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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 BY CIBC
TABLE OF CONTENTSPageI. INTRODUCTION AND OVERVIEW .......................... 1A. Year-End 97 Crisis................................ 4B. The 97-00 Successes – Enron's S<strong>to</strong>ck Soars ................... 5C. The Partnerships <strong>and</strong> SPEs............................11D. Enron Energy Services ("EES") .........................16E. Enron Broadb<strong>and</strong> ("EBS") ............................17F. New Power....................................18G. Enron's Access <strong>to</strong> the Capital Markets......................20H. Late 00/Early 01 Prop-Up ............................21I. The Impend<strong>in</strong>g Collapse .............................22J. The End......................................23II.SUMMARY OF CIBC'S FACTUAL INVOLVEMENT AND LEGALLIABILITY........................................29III. DETAILED FACTUAL ALLEGATIONS REGARDING CIBC ............42IV. CIBC IS LIABLE UNDER 1933 ACT TO PURCHASERS OF ENRON'S 7.375%NOTES IN 5/99 FOR SELLING THOSE SECURITIES PURSUANT TO AFALSE AND MISLEADING REGISTRATION STATEMENT ............57V. CIBC CAN BE LIABLE UNDER 1934 ACT §10(b) AND RULE 10b-5 (i) FORMAKING FALSE STATEMENTS, OR (ii) FOR PARTICIPATING IN AFRAUDULENT SCHEME OR COURSE OF BUSINESS THAT OPERATEDAS A FRAUD OR DECEIT ON PURCHASERS OF ENRON'S SECURITIES,OR (iii) FOR EMPLOYING ACTS OR MANIPULATIVE DEVICES TODECEIVE.........................................60VI.VII.CIBC MADE FALSE AND MISLEADING STATEMENTS INREGISTRATION STATEMENTS AND ANALYSTS REPORTS ...........81CIBC ACTED WITH SCIENTER, I.E., WITH "THE REQUIRED STATE OFMIND" AND HAD MOTIVES AND THE OPPORTUNITY TO DEFRAUDENRON INVESTORS, AS IT MADE FALSE STATEMENTS, EMPLOYEDDECEPTIVE 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 ..............101- i -
PageVIII. CONCLUSION .....................................122- ii -
Rozměry4356282977466884SR051; SR101; SR15110746SR200; SR2506krabice IP66 pro TEV1,2110krabice IP66 pro TEV3110SR300; SR400; SR60050662520110110M20x1.5 M20x1.5 M16x1.5M20x1.5506617M20x1.5M16x1.527272727134
PageCompetitive Assocs., Inc. v. Laventhol, Krekste<strong>in</strong>, Horwath & Horwath,516 F.2d 811 (2d Cir. 1975) ..........................33, 70, 73Conley v. Gibson,355 U.S. 41 (1957) ..................................1, 42Cooper v. Pickett,137 F.3d 616 (9th Cir. 1998) ............................passimDasho v. Susquehanna Corp.,380 F.2d 262 (7th Cir. 1967) ............................. 106Ernst & Ernst v. Hochfelder,425 U.S. 185 (1976) ............................32, 33, 61, 68Escott v. Barchris Constr. Corp.,283 F. Supp. 643 (S.D.N.Y. 1968) ...........................57Feit v. Leasco Data Process<strong>in</strong>g Equip. Corp.,332 F. Supp. 544 (E.D.N.Y. 1971) ...........................58F<strong>in</strong>e v. Am. Solar K<strong>in</strong>g Corp.,919 F.2d 290 (5th Cir. 1990) ..............................34F<strong>in</strong>kel v. Docutel/Olivetti Corp.,817 F.2d 356 (5th Cir. 1987) ............................33, 61Fitzgerald v. Henderson,251 F.3d 345 (2d Cir. 2001),petition for cert. filed, (Aug. 29, 2001) .........................44Flecker v. Hollywood Entm't Corp.,No. 95-1926-MA, 1997 U.S. Dist. LEXIS 5329(D. Or. Feb. 12, 1997) .............................39, 76, 77Harris v. United States,48 F.2d 771 (9th Cir. 1931) ..............................73Heller v. Am. Indus. Props. Reit,No. SA-97-CA-1315-EP, 1998 U.S. Dist. LEXIS 23286(W.D. Tex. Sept. 28, 1998) ...............................62Herman & MacLean v. Huddles<strong>to</strong>n,459 U.S. 375 (1983) ..................................30Hill v. Hanover Energy, Inc.,No. 91-1964 (JHG), 1991 U.S. Dist. LEXIS 18566(D.D.C. Dec. 16, 1991) .................................71In re Boe<strong>in</strong>g Sec. Litig.,40 F. Supp. 2d 1160 (W.D. Wash. 1998) .........................1- iv -
PageIn re Cascade Int'l Sec. Litig.,840 F. Supp. 1558 (S.D. Fla. 1993) ........................40, 79In re Health Mgmt. Inc. Sec. Litig.,970 F. Supp. 192 (E.D.N.Y. 1997) ........................ 63, 104In re Hellenic Inc.,252 F.3d 391 (5th Cir. 2001) ............................. 116In re Honeywell Int'l Sec. 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. Noteholders Sec. Litig.,174 F. Supp. 2d 144 ................................passimIn re Nissan Mo<strong>to</strong>r Corp. Antitrust Litig.,430 F. Supp. 231 (S.D. Fla. 1977) .......................... 106In re Richmond Corp.,41 S.E.C. 398 (1963) ..................................57In re Sec. Litig. BMC S<strong>of</strong>tware, Inc.,183 F. Supp. 2d 860 (S.D. Tex. 2001) .................. 35, 65, 72, 104In re S<strong>of</strong>tware Toolworks Sec. Litig.,50 F.3d 615 (N.D. Cal. 1995) ............................ 105In re Union Carbide Corp. Consumer Prods. Bus. Sec. Litig.,676 F. Supp. 458 (S.D.N.Y. 1987) ...........................72In re Waste Mgmt. Inc. Sec. Litig.,No. H-99-2183 (S.D. Tex. Aug. 16, 2001) .....................35, 65In re ZZZZ Best Sec. Litig.,864 F. Supp. 960 (C.D. Cal. 1994) .........................passimLawal v. British Airways, PLC,812 F. Supp. 713 (S.D. Tex. 1992) ..........................1, 42Lemmer v. Nu-Kote Hold<strong>in</strong>g, Inc.,No. 3:98:CV-0161-L, 2001 U.S. Dist. LEXIS 13978(N.D. Tex. Sept. 6, 2001) ..........................104, 107, 108Lip<strong>to</strong>n v. Documation, Inc.,734 F.2d 740 (11th Cir. 1984) ...........................73, 74Little v. United States,73 F.2d 861 (10th Cir. 1934) ..............................43- v -
PageLone Star Ladies Inv. Club v. Schlotzsky's Inc.,___ F.3d ___, 2001 WL 21259 (5th Cir. Jan. 9, 2001) ...............58, 59McNamara 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, 79Meason v. Bank <strong>of</strong> Miami,652 F.2d 542 (5th Cir. 1981) ............................36, 66Melder v. Morris,27 F.3d 1097 (5th Cir. 1994) ............................58, 59Murphy v. Hollywood Entm't Corp.,No. 95-1926-MA, 1996 U.S. Dist. LEXIS 22207(D. Or. May 9, 1996) ................................passimNathenson v. Zonagen Inc.,267 F.3d 400 (5th Cir. 2001) ........................... 42, 104Paul F. New<strong>to</strong>n & Co. v. Texas Commerce Bank,630 F.2d 1111 (5th Cir. 1980) ...........................36, 66Richardson v. MacArthur,451 F.2d 35 (10th Cir. 1971) ........................... 70, 104Rub<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, 195 (1963) ............................. 66, 104SEC v. First Jersey Sec.,101 F.3d 1450 (2d Cir. 1996) ............................passimSEC v. Nat'l Bankers Life Ins. Co.,324 F. Supp. 189 (N.D. Tex. 1971), aff'd,448 F.2d 652 (5th Cir. 1971) ........................105, 106, 107SEC v. Seaboard Corp.,677 F.2d 1301 (9th Cir. 1982) .............................70SEC v. U.S. Envtl., Inc.,155 F.3d 107 (2d Cir. 1998) ............................40, 80SEC v. Z<strong>and</strong>ford,__ U.S. __, No. 01-147, 2002 U.S. LEXIS 4023(June 3, 2002) ..................................35, 36, 65STI Classic Fund v. Boll<strong>in</strong>ger Indus.,No. 3-96-CV-823-R, 1996 U.S. Dist. LEXIS 21553(N.D. Tex. Oct. 25, 1996) ...............................42- vi -
PageSanta Fe Indus., Inc. v. Green,430 U.S. 462 (1977) ..............................66, 69, 71Scheuer v. Rhodes,416 U.S. 232 (1974) .................................1, 42Schlick v. Penn-Dixie Cement Corp.,507 F.2d 374 (2d Cir. 1974) ............................. 106Scholnick v. Cont<strong>in</strong>ental Bank,752 F. Supp. 1317 (E.D. Mich. 1990) .......................40, 80Shores 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) ............................. 116Steere Tank L<strong>in</strong>es, Inc. v. United States,330 F.2d 719 (5th Cir. 1964) ...........................117, 118Summit Props. v. Hoechst Celanese Corp.,214 F.3d 556 (5th Cir. 2000), cert. denied,531 U.S. 1132 (2001) ..................................33Super<strong>in</strong>tendent <strong>of</strong> Ins. v. Bankers Life & Cas. Co.,404 U.S. 6 (1971) ..................................passimTuchman 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) ............................32, 61United States v. Alvarez,625 F.2d 1196 (5th Cir. 1980) ............................ 105United States v. Ashdown,509 F.2d 793 (5th Cir. 1975) ..............................43United States v. Bank <strong>of</strong> New Engl<strong>and</strong>, N.A.,821 F.2d 844 (1st Cir. 1987) ............................. 117United States v. Blosser,440 F.2d 697 (10th Cir. 1971) .............................43United States v. Craig,573 F.2d 455 (7th Cir. 1977) ...........................104, 105United States v. Elam,678 F.2d 1234 (5th Cir. 1982) ............................ 104- vii -
PageUnited States v. Garv<strong>in</strong>,565 F.2d 519 (8th Cir. 1977) ..............................44United States v. Hask<strong>in</strong>s,737 F.2d 844 (10th Cir. 1984) .............................43United States v. Humphrey,104 F.3d 65 (5th Cir. 1997) ............................. 105United States v. Lanier,838 F.2d 281 (8th Cir. 1988) ............................. 105United States v. Lothian,976 F.2d 1257 (9th Cir. 1992) ............................ 105United States v. Marconi,899 F. Supp. 458 (C.D. Cal. 1995) ...........................43United States v. Maxwell,920 F.2d 1028 (D.C. Cir. 1990) ........................... 105United States v. O'Hagan,521 U.S. 642 (1997) ................................passimUnited States v. Read,658 F.2d 1225 (7th Cir. 1981) ..........................105, 106United States v. Whitt,718 F.2d 1494 (10th Cir. 1983) ............................43United States v. Wieh<strong>of</strong>f,748 F.2d 1158 (7th Cir. 1984) ............................ 105United States v. Wilshire Oil Co.,427 F.2d 969 (10th Cir. 1970) ............................ 118Young v. Nationwide Life Ins. Co.,2 F. Supp. 2d 914 (S.D. Tex. 1998) ...........................1Ziemba v. Cascade Int'l, Inc.,256 F.3d 1194 (11th Cir. 2001) ..........................36, 65Zishka v. Am. Pad & Paper Co.,No. 3:98-CV-0660-M, 2000 U.S. Dist. LEXIS 13300(N.D. Tex. Sept. 13, 2000) ................................3Zuckerman v. Foxmeyer Health Corp.,4 F. Supp. 2d 618 (N.D. Tex. 1998) ...........................1- viii -
PageSTATUTES, RULES AND REGULATIONS15 U.S.C.§77a .........................................passim§77k ...........................................37§77k(a)(5) .....................................29, 59§77k(b)(3) .....................................29, 59§78j(b) .......................................passim§78m(a) .......................................58, 99§78u-4 .........................................3718 U.S.C.§1341 ......................................... 105Federal Rules <strong>of</strong> Civil ProcedureRule 8.........................................2, 77Rule 9(b) ...................................2, 58, 59, 60Rule 12(b)(6)......................................4217 C.F.R.§240.10b-5 .....................................passimSECONDARY AUTHORITIESRestatement (Second) <strong>of</strong> Torts (1979)§875 ......................................... 106LEGISLATIVE HISTORYH.R. Conf. Rep. No. 104-369 (1995), repr<strong>in</strong>ted <strong>in</strong> 1995 U.S.C.C.A.N. 679 .........41- ix -
I. INTRODUCTION AND 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 long. Some claim it is not detailed enough. Everyone denies responsibility.Not one defendant has seen it fit <strong>to</strong> answer. Every defendant seeks <strong>to</strong> avoid accountability by rais<strong>in</strong>gtechnical plead<strong>in</strong>g arguments based on the Private Securities Litigation Reform Act <strong>of</strong> 1995 ("95Act") 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, R.) (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. Dismissal is appropriate only if it appears that no relief couldbe granted under 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, 20 F.3d 160, 166 (5th Cir. 1994) (cit<strong>in</strong>g Conley v. Gibson, 355 U.S. 41, 45-46 (1957));Tuchman v. DSC Communications Corp., 818 F. Supp. 971, 974 (N.D. Tex. 1993), aff'd, 14 F.3d1061 (5th Cir. 1994); Calliott, 2000 U.S. Dist. LEXIS 4368, at *3. Unless otherwise noted,emphasis is added <strong>and</strong> citations are omitted throughout.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, "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 "Major debacle <strong>of</strong> his<strong>to</strong>ric dimensions ...."- 1 -
does not appear <strong>to</strong> have the same salutary impact with respect <strong>to</strong> deterr<strong>in</strong>g defendants from fil<strong>in</strong>gmeritless motions <strong>to</strong> dismiss. 3Canadian Imperial Bank <strong>of</strong> Commerce ("CIBC") denigrates the detailed CC as a "puzzleplead<strong>in</strong>g" that violates Fed. R. Civ. P. 8. But, the CC is <strong>of</strong> the same style <strong>and</strong> format susta<strong>in</strong>ed bythis Court <strong>in</strong> In re L<strong>and</strong>ry's Seafood Restaurants, Inc. Sec. Litig., No. H-99-1948 (S.D. Tex. Feb. 20,2001) – a decision defendants basically ignore – <strong>and</strong> <strong>in</strong> many other reported <strong>and</strong> unreporteddecisions. The "puzzle plead<strong>in</strong>g" charge has been repeatedly rejected by courts which respect goodfaith efforts <strong>to</strong> provide the k<strong>in</strong>d <strong>of</strong> detail <strong>and</strong> <strong>in</strong>dividuality required by the 95 Act – especially <strong>in</strong>complex multi-party cases. As Judge Debevoise stated <strong>in</strong> susta<strong>in</strong><strong>in</strong>g a lengthy aga<strong>in</strong>st a publiccompany <strong>and</strong> its <strong>of</strong>ficers <strong>and</strong> direc<strong>to</strong>rs:Defendants challenge the Compla<strong>in</strong>t, claim<strong>in</strong>g that rather than be<strong>in</strong>g a "short<strong>and</strong> pla<strong>in</strong> statement <strong>of</strong> the claim" <strong>in</strong> conformity with Fed. R. Civ. P. 8, it is "puzzleplead<strong>in</strong>g" that fails <strong>to</strong> meet the requirements <strong>of</strong> Rule 9(b) <strong>and</strong> the Private SecuritiesLitigation Reform Act (the "Reform Act"). The Compla<strong>in</strong>t certa<strong>in</strong>ly is not short,but if it is a puzzle, it is meant for a child <strong>and</strong> can be assembled readily. The issuesare whether pla<strong>in</strong>tiffs plead actionable misrepresentations with sufficient particularity<strong>and</strong> whether pla<strong>in</strong>tiffs adequately plead scienter on the part <strong>of</strong> Honeywell <strong>and</strong> eachIndividual Officer.In re Honeywell Int'l Sec. Litig., 182 F. Supp. 2d 414, 416 (D.N.J. 2002). In truth, 1–74 <strong>of</strong> the CCprovide a relatively succ<strong>in</strong>ct summary <strong>of</strong> the CC, while the balance <strong>of</strong> the CC provides the detailrequired by Rule 9(b) <strong>and</strong> the 95 Act, thus satisfy<strong>in</strong>g pla<strong>in</strong>tiffs' dual plead<strong>in</strong>g obligations. 43While the banks proclaim their <strong>in</strong>nocence <strong>and</strong> <strong>in</strong>sist that they acted properly, without conflic<strong>to</strong>r corruption, <strong>and</strong> <strong>in</strong> accordance with normal commercial lend<strong>in</strong>g <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>g activities,these denials r<strong>in</strong>g hollow <strong>in</strong> light <strong>of</strong> the recent revelations <strong>of</strong> corruption on Wall Street. See MarciaVickers <strong>and</strong> Mike France, "Wall St.: How Corrupt is it?," Bus<strong>in</strong>ess Week, 5/13/02, attached as Ex. 1<strong>to</strong> pla<strong>in</strong>tiffs' Appendix.If it is "irrational" <strong>to</strong> engage <strong>in</strong> acts that violate the law, then it appears Wall Street isderanged. However, if it is irrational <strong>to</strong> violate the law because <strong>of</strong> the risk <strong>of</strong> f<strong>in</strong>ancial loss <strong>and</strong>punishment that accompanies illegal conduct, then presumably no one would ever violate the law<strong>and</strong> acceptance <strong>of</strong> this after-the-fact rationale would provide all wrong doers from embezzlers <strong>to</strong>bank robbers <strong>to</strong> price fixers <strong>and</strong> sophisticated securities viola<strong>to</strong>rs with a built-<strong>in</strong> defense.4All references <strong>to</strong> "_-_" are <strong>to</strong> paragraphs <strong>of</strong> pla<strong>in</strong>tiffs' CC filed 4/8/02.- 2 -
CIBC 5 portrays itself as a victim <strong>of</strong> the Enron debacle – a f<strong>in</strong>ancial <strong>in</strong>stitution that was merelyrender<strong>in</strong>g ord<strong>in</strong>ary bank<strong>in</strong>g services <strong>to</strong> Enron when it became engulfed <strong>in</strong> the Enron conflagration.But this is not what is pleaded <strong>in</strong> the CC, <strong>and</strong> what is pleaded is what controls <strong>in</strong> the motion <strong>to</strong>dismiss context. 6 What the CC pleads <strong>and</strong> what now must be accepted as true is that CIBC is liableunder the 1933 7 <strong>and</strong> 1934 8 Acts because it (i) sold Enron <strong>and</strong> Enron-related securities via falseRegistration Statements; (ii) issued false analysts' reports on Enron; (iii) employed acts, contrivances5CIBC is an <strong>in</strong>tegrated f<strong>in</strong>ancial services <strong>in</strong>stitution that, through subsidiaries <strong>and</strong> divisions(such as CIBC Oppenheimer or CIBC World Markets), provides commercial <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>gservices <strong>and</strong> advisory services, <strong>in</strong>clud<strong>in</strong>g act<strong>in</strong>g as underwriter <strong>in</strong> the sale <strong>of</strong> corporate securities <strong>and</strong>provid<strong>in</strong>g <strong>in</strong>vestment analysis <strong>and</strong> op<strong>in</strong>ions on public companies. 103.6CIBC suggests we sued the wrong party. We th<strong>in</strong>k not. S<strong>in</strong>ce the allegations <strong>of</strong> CIBC's<strong>in</strong>volvement here <strong>in</strong>volve both its <strong>in</strong>vestment bank<strong>in</strong>g operations <strong>and</strong> its commercial operations, theparent corporate entity which is responsible for all the corporation's operations seems the appropriatedefendant. Pla<strong>in</strong>tiffs clearly allege defendant CIBC "is a large <strong>in</strong>tegrated f<strong>in</strong>ancial services<strong>in</strong>stitution that through its controlled subsidiaries <strong>and</strong> divisions (such as CIBC Oppenheimer orCIBC World Markets (collectively "CIBC")) ... engaged <strong>and</strong> participated <strong>in</strong> the scheme <strong>to</strong> defraudpurchasers <strong>of</strong> Enron securities <strong>and</strong> Enron's course <strong>of</strong> bus<strong>in</strong>ess which operated as a fraud <strong>and</strong> decei<strong>to</strong>n purchasers <strong>of</strong> Enron's securities" by render<strong>in</strong>g various services <strong>to</strong> Enron. 103. Moreover,"[w]hether a subsidiary is a separate entity is a question <strong>of</strong> fact." Burnside v. S<strong>and</strong>ers Assocs., Inc.,507 F. Supp. 165, 166 (N.D. Tex. 1980), aff'd, 643 F.2d 389 (5th Cir. 1981). The issue <strong>of</strong> whetherthe parent corporation is responsible for acts <strong>of</strong> its subsidiaries is "heavily fact-specific." UnitedStates v. Jon-T Chems., Inc., 768 F.2d 686, 694 (5th Cir. 1985). CIBC's cases are not <strong>to</strong> the contrary.United States v. Bestfoods, 524 U.S. 51 (1998) actually holds <strong>in</strong> certa<strong>in</strong> situations, where as here,"'the alleged wrong can seem<strong>in</strong>gly be traced <strong>to</strong> the parent through the conduit <strong>of</strong> its own personnel<strong>and</strong> management' <strong>and</strong> 'the parent is directly a participant <strong>in</strong> the wrong compla<strong>in</strong>ed <strong>of</strong>.' ... [T]he parentis directly liable for its own actions." Id. at 64-65. Similarly, <strong>in</strong> Abbell Credit Corp. v. Bank <strong>of</strong>America Corp., No. 01 C 2227, 2002 WL 335320 (N.D. Ill. Mar. 1, 2002), pla<strong>in</strong>tiffs named bothBank <strong>of</strong> America Corporation <strong>and</strong> Banc <strong>of</strong> America Securities as defendants seek<strong>in</strong>g <strong>to</strong> hold bothdefendants liable for fail<strong>in</strong>g <strong>to</strong> disclose that Bank <strong>of</strong> America Corporation provided a credit facility<strong>to</strong> the company which issued the commercial paper pla<strong>in</strong>tiffs claimed they were deceived <strong>in</strong><strong>to</strong> buy<strong>in</strong>gby Banc <strong>of</strong> America Securities. The court dismissed claims aga<strong>in</strong>st Bank <strong>of</strong> America Corporation,not<strong>in</strong>g that pla<strong>in</strong>tiffs' compla<strong>in</strong>t "does not allege, <strong>and</strong> pla<strong>in</strong>tiffs do not argue, that corporateformalities should be disregarded <strong>in</strong> this case." Id. at *4. Also, pla<strong>in</strong>tiff Abbell failed <strong>to</strong> allege direct<strong>in</strong>volvement <strong>of</strong> the parent corporation <strong>in</strong> the wrongdo<strong>in</strong>g. Here, by contrast, pla<strong>in</strong>tiffs clearly allegeCIBC the corporate parent was directly <strong>in</strong>volved <strong>and</strong> should be held liable.CIBC also relies on Zishka v. Am. Pad & Paper Co., No. 3:98-CV-0660-M, 2000 U.S. Dist.LEXIS 13300 (N.D. Tex. Sept. 13, 2000). In that case the court found pla<strong>in</strong>tiffs' allegations aga<strong>in</strong>sta bank hold<strong>in</strong>g company were <strong>in</strong>sufficient because, accord<strong>in</strong>g <strong>to</strong> the court, pla<strong>in</strong>tiffs failed <strong>to</strong> "showhow [the bank] committed the wrongdo<strong>in</strong>g alleged." Id. at *13-*14. The court found it was notenough <strong>to</strong> allege "conclusorily" that the bank controlled or conspired with subsidiaries. Id. at *14.Here, by contrast, pla<strong>in</strong>tiffs have provided detailed <strong>in</strong>formation regard<strong>in</strong>g CIBC's <strong>in</strong>volvement <strong>in</strong> thefraudulent scheme. See 103, 715-734.715 U.S.C. §77a, et seq.815 U.S.C. §78a, et seq.- 3 -
<strong>and</strong> manipulative or deceptive devices; <strong>and</strong> (iv) participated <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, purchasers <strong>of</strong> Enron's securities between 10/18/98 <strong>and</strong>11/27/01 (the "Class Period").A. Year-End 97 CrisisThe fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess <strong>in</strong>volv<strong>in</strong>g Enron f<strong>in</strong>ds its orig<strong>in</strong> <strong>in</strong> mid-97when Enron suffered huge losses on British natural gas <strong>and</strong> MTBE transactions which called <strong>in</strong><strong>to</strong>question its trad<strong>in</strong>g <strong>and</strong> f<strong>in</strong>ancial risk management statistics. Analysts downgraded Enron's s<strong>to</strong>ck<strong>and</strong> lowered their forecasts <strong>of</strong> Enron's future earn<strong>in</strong>gs growth. Enron's s<strong>to</strong>ck lost one-third <strong>of</strong> itsvalue <strong>and</strong> Enron's executives' performance-based bonuses were slashed. Enron was determ<strong>in</strong>ed <strong>to</strong>halt its s<strong>to</strong>ck's decl<strong>in</strong>e <strong>and</strong> push it back <strong>to</strong> higher levels. Enron knew this could only beaccomplished by report<strong>in</strong>g stronger-than-expected f<strong>in</strong>ancial results, thus enabl<strong>in</strong>g it <strong>to</strong> crediblyforecast stronger future earn<strong>in</strong>gs growth. Unfortunately, Enron's actual bus<strong>in</strong>ess operations were notcapable <strong>of</strong> generat<strong>in</strong>g such results. 8.To make matters worse, <strong>in</strong> late 12/97, Enron learned that an entity it had established with anoutside <strong>in</strong>ves<strong>to</strong>r – Jo<strong>in</strong>t Energy Development Incorporated ("JEDI") – <strong>and</strong> had done transactions with<strong>to</strong> generate 40% <strong>of</strong> the pr<strong>of</strong>its Enron reported dur<strong>in</strong>g 97 – had <strong>to</strong> be restructured, as the outside<strong>in</strong>ves<strong>to</strong>r was go<strong>in</strong>g <strong>to</strong> withdraw from JEDI. This created a crisis. Because the outside <strong>in</strong>ves<strong>to</strong>r <strong>in</strong>JEDI had been <strong>in</strong>dependent <strong>of</strong> Enron, JEDI had not been consolidated <strong>in</strong><strong>to</strong> Enron's f<strong>in</strong>ancialstatements, i.e., Enron did deals with JEDI as an <strong>in</strong>dependent party, recognized pr<strong>of</strong>its <strong>and</strong> did notcarry JEDI's debt on its books. Thus, unless JEDI could be quickly restructured with a new,<strong>in</strong>dependent <strong>in</strong>ves<strong>to</strong>r, Enron would have <strong>to</strong> wipe out all <strong>of</strong> the pr<strong>of</strong>itable transactions it had donewith JEDI <strong>in</strong> 97 – put JEDI's $700 million debt on Enron's balance sheet – <strong>and</strong> lose the ability<strong>to</strong> generate pr<strong>of</strong>its from similar such deals with JEDI's successor go<strong>in</strong>g forward. 9.However, Enron could not f<strong>in</strong>d a legitimate buyer for the outside <strong>in</strong>ves<strong>to</strong>r's <strong>in</strong>terest <strong>in</strong>JEDI. So Enron quickly formed a new entity – Chewco – which Enron controlled, <strong>to</strong> buy the outside<strong>in</strong>ves<strong>to</strong>r's <strong>in</strong>terest <strong>in</strong> JEDI. Chewco did not have an outside equity <strong>in</strong>ves<strong>to</strong>r which was an<strong>in</strong>dependent third party. So, Barclays Bank loaned $240 million <strong>to</strong> Chewco <strong>to</strong> fund this purchase,requir<strong>in</strong>g a secret guarantee from Enron. Barclays also loaned the money <strong>to</strong> two straw parties- 4 -
<strong>to</strong> provide for their purported "equity" <strong>in</strong>vestment <strong>in</strong> Chewco. Because Barclays knew that thepurported equity <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> Chewco were, <strong>in</strong> fact, Enron "strawmen," Barclays requiredChewco <strong>to</strong> support the purported "equity loans" Barclays made <strong>to</strong> the two "strawmen" via a $6.6million reserve paid <strong>to</strong> Barclays! Because there was no <strong>in</strong>dependent outside <strong>in</strong>ves<strong>to</strong>r <strong>in</strong> Chewco,Chewco was required <strong>to</strong> have been consolidated with Enron <strong>and</strong> all <strong>of</strong> Enron's 97 pr<strong>of</strong>its fromtransactions with JEDI should have been elim<strong>in</strong>ated! 10.The Chewco deal avoided a disaster for Enron by keep<strong>in</strong>g the previously recorded JEDIpr<strong>of</strong>its <strong>in</strong> place, <strong>in</strong>flat<strong>in</strong>g Enron's 97 reported pr<strong>of</strong>its <strong>and</strong> keep<strong>in</strong>g millions <strong>of</strong> dollars <strong>of</strong> debt <strong>of</strong>f itsbooks. Chewco was now also positioned <strong>to</strong> serve as a controlled entity which Enron could use <strong>to</strong>do non-arm's-length transactions with, creat<strong>in</strong>g at least $350 million <strong>in</strong> phony pr<strong>of</strong>its for Enron <strong>and</strong>allow<strong>in</strong>g Enron <strong>to</strong> conceal millions <strong>of</strong> dollars <strong>of</strong> debt. Between 98 <strong>and</strong> 01, Enron <strong>and</strong> its bankerswould create numerous other secretly controlled partnerships <strong>and</strong> entities <strong>and</strong> use them <strong>to</strong>generate 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>Enron debt. 11.B. The 97-00 Successes – Enron's S<strong>to</strong>ck SoarsAs Enron reported better-than-expected year-end 97 f<strong>in</strong>ancial results, its s<strong>to</strong>ck movedhigher. Dur<strong>in</strong>g 98 through mid-01, Enron appeared <strong>to</strong> evolve <strong>in</strong><strong>to</strong> an enormously pr<strong>of</strong>itable highgrowthenterprise, reach<strong>in</strong>g annual revenues <strong>of</strong> $100 billion by 00, with annual pr<strong>of</strong>its <strong>of</strong> $1.2billion, present<strong>in</strong>g a very strong balance sheet that entitled it <strong>to</strong> an <strong>in</strong>vestment grade credit rat<strong>in</strong>g.By 01, Enron had become the 7th largest U.S. corporation <strong>and</strong> was consistently report<strong>in</strong>g higherthan-forecastedearn<strong>in</strong>gs each quarter <strong>and</strong> forecast<strong>in</strong>g cont<strong>in</strong>ued strong growth. 12-13. Enronex<strong>to</strong>lled the success <strong>and</strong> earn<strong>in</strong>g power <strong>of</strong> its Wholesale Energy trad<strong>in</strong>g bus<strong>in</strong>ess ("WEOS"), its retailEnergy Services bus<strong>in</strong>ess ("EES") <strong>and</strong> its Broadb<strong>and</strong> Content Delivery <strong>and</strong> Access Trad<strong>in</strong>g, i.e.,<strong>in</strong>termediation, bus<strong>in</strong>ess ("EBS"). 2.Throughout 98 <strong>and</strong> 99, as Enron reported record pr<strong>of</strong>its <strong>and</strong> a strong f<strong>in</strong>ancial position, Enron<strong>in</strong> releases, reports <strong>and</strong> conversations with <strong>in</strong>ves<strong>to</strong>rs <strong>and</strong> analysts <strong>and</strong> Enron's banks – <strong>in</strong>clud<strong>in</strong>gCIBC – <strong>in</strong> analyst reports, stated (14(a)):• Enron's strong results were due <strong>to</strong> the success <strong>of</strong> all <strong>of</strong> its bus<strong>in</strong>ess l<strong>in</strong>es.- 5 -
• Enron had a lead<strong>in</strong>g position <strong>in</strong> each <strong>of</strong> its bus<strong>in</strong>esses. Enron had an extremelystrong franchise position.• Wessex Water would be accretive <strong>to</strong> Enron's bus<strong>in</strong>ess now <strong>and</strong> a $20 billion bus<strong>in</strong>ess<strong>in</strong> five years. Azurix Corp. was becom<strong>in</strong>g a major global water company.• International projects would drive major earn<strong>in</strong>gs growth for Enron. The Dabhol,India power project would contribute <strong>to</strong> earn<strong>in</strong>gs <strong>in</strong> 99 <strong>and</strong> beyond.• WEOS's bus<strong>in</strong>ess rema<strong>in</strong>ed strong.• EES was exceed<strong>in</strong>g expectations for contracts <strong>and</strong> pr<strong>of</strong>itability. EES was add<strong>in</strong>gbillions <strong>in</strong> new contracts <strong>and</strong> would be pr<strong>of</strong>itable by 4thQ 00.• Enron was optimistic about its broadb<strong>and</strong> bus<strong>in</strong>ess. EBS was fir<strong>in</strong>g on track.• Enron's tremendous competitive advantages enabled it <strong>to</strong> achieve strong EPS growth.• Enron was very well managed <strong>and</strong> knew how <strong>to</strong> manage <strong>and</strong> mitigate risk. Enronhad effectively used <strong>of</strong>f-balance sheet non-recourse f<strong>in</strong>anc<strong>in</strong>g. Enron had a strongbalance sheet. Enron was a master <strong>of</strong> risk management.• No other company <strong>of</strong>fered such impressive susta<strong>in</strong>able growth.• Enron was hitt<strong>in</strong>g on all eight cyl<strong>in</strong>ders. Enron's outlook was excellent. Enron wasvery optimistic.• Enron was a global powerhouse, with EPS growth <strong>to</strong> exceed 17%. Enron wouldma<strong>in</strong>ta<strong>in</strong> strong earn<strong>in</strong>gs growth for years.Dur<strong>in</strong>g 00, as Enron reported record annual pr<strong>of</strong>its <strong>and</strong> a very strong f<strong>in</strong>ancial position, Enron<strong>and</strong> its banks – <strong>in</strong>clud<strong>in</strong>g CIBC – stated (14(b)):• Enron's strong f<strong>in</strong>ancial results were due <strong>to</strong> strong results <strong>in</strong> all operations.• 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 <strong>of</strong> 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 broadb<strong>and</strong> trad<strong>in</strong>g was accelerat<strong>in</strong>g. The market was larger than expected, <strong>and</strong>would reach $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.- 6 -
• 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. 15.Enron's apparent success <strong>and</strong> forecasts <strong>of</strong> strong pr<strong>of</strong>it growth gave Enron <strong>and</strong> its banks ready access<strong>to</strong> the capital markets by which they raised billions <strong>of</strong> dollars by sell<strong>in</strong>g newly issued Enronsecurities <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>cksoared <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 these levels formonths, as shown below (15):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 by defendants tha<strong>to</strong>perated as a fraud <strong>and</strong> deceit on the purchasers <strong>of</strong> Enron's publicly traded securities. The fraudulentscheme was accomplished by, <strong>in</strong>ter alia, Enron <strong>and</strong> several banks, <strong>in</strong>clud<strong>in</strong>g CIBC, which pocketedmillions <strong>of</strong> dollars a year from Enron – which by 97-98 had become the golden goose <strong>of</strong> Wall Street.17.- 7 -
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.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."- 8 -
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 (who was a former Andersenaccountant) wrote Lay, tell<strong>in</strong>g him the 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> the SPE transactions which Enron's banks – <strong>in</strong>clud<strong>in</strong>g CIBC – had structured <strong>and</strong>funded, that noth<strong>in</strong>g "will protect Enron if these transactions are ever disclosed <strong>in</strong> the bright light<strong>of</strong> day" – warn<strong>in</strong>g that many employees believed "[W]e're such a crooked company." 51.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 havebeen on 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> the largest 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 orthose <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, becauseEnron's reported 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 9 <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>9Enron 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> <strong>in</strong> fact 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 trackrecord which 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 -
eport grow<strong>in</strong>g pr<strong>of</strong>its, Enron was forced <strong>to</strong> not only 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> CIBC, Enron had capitalized certa<strong>in</strong> controlled entities it wasdo<strong>in</strong>g phony deals with (<strong>in</strong>clud<strong>in</strong>g entities CIBC was fund<strong>in</strong>g), with shares <strong>of</strong> Enron s<strong>to</strong>ck <strong>and</strong> hadagreed <strong>to</strong> issue 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 pricedecl<strong>in</strong>ed below certa<strong>in</strong> "trigger prices," i.e., $83, $81, $79, $68, $60, $57, $52, $48, $34 <strong>and</strong> $19per 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 gradecredit rat<strong>in</strong>g. Because <strong>of</strong> the "triggers" <strong>and</strong> the way Enron capitalized these entities, it wasabsolutely vital <strong>to</strong> Enron, CIBC <strong>and</strong> the other participants <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong>bus<strong>in</strong>ess that 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>vestmentgrade" credit rat<strong>in</strong>g, otherwise the scheme would unravel. 18, 20. 10Enron 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 CIBC – <strong>to</strong> susta<strong>in</strong> its bus<strong>in</strong>ess operations <strong>and</strong> so thes<strong>to</strong>ck issuance "triggers" would not be hit which would force Enron <strong>in</strong><strong>to</strong> a death spiral. 20.10Enron'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 (JP Morgan <strong>and</strong> CitiGroup) with CIBC as a participat<strong>in</strong>g bank,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. Italso 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 -
C. The Partnerships <strong>and</strong> SPEsTo falsify Enron's reported f<strong>in</strong>ancial results, Enron <strong>and</strong> its banks engaged <strong>in</strong> a series <strong>of</strong>purported "partnership" <strong>and</strong> "related party" transactions with the entities known as SPEs. A publiccompany that conducts bus<strong>in</strong>ess with an SPE may treat that SPE as if it were an <strong>in</strong>dependent entityonly if it does not control the SPE. And, at a bare m<strong>in</strong>imum, two other conditions must be met:(i) an owner <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>dependent party mustexercise control <strong>of</strong> the SPE. 21.In 99, Enron <strong>and</strong> several <strong>of</strong> Enron's banks created two LJM partnerships (LJM <strong>and</strong> LJM2),which Enron secretly controlled. Enron then engaged <strong>in</strong> numerous non-arm's-lengthtransactions – manipulative or deceptive contrivances – with the LJM partnerships <strong>and</strong> associatedSPEs, which <strong>in</strong>flated Enron's reported pr<strong>of</strong>its by more than a billion dollars – at the same timeenrich<strong>in</strong>g Enron's CFO (Fas<strong>to</strong>w) <strong>and</strong> his friends <strong>and</strong> all <strong>of</strong> Enron's banks or bankers named asdefendants – <strong>in</strong>clud<strong>in</strong>g CIBC or its <strong>to</strong>p executives – who had been secretly allowed <strong>to</strong> <strong>in</strong>vest <strong>in</strong> theLJM2 partnership as a reward for their participation <strong>in</strong> the scheme – by hundreds <strong>of</strong> millions <strong>of</strong>dollars. The reason for establish<strong>in</strong>g these partnerships was that they would permit Enron <strong>to</strong>accomplish transactions it could not otherwise accomplish with an <strong>in</strong>dependent entity, byprovid<strong>in</strong>g Enron with a buyer <strong>of</strong> assets that Enron wanted <strong>to</strong> sell. 23, 29, 646-647.Thus, LJM2 was one <strong>of</strong> the primary vehicles used <strong>to</strong> falsify Enron's f<strong>in</strong>ancial results dur<strong>in</strong>g99-01, which was secretly controlled by Enron <strong>and</strong> used <strong>to</strong> create numerous SPEs (<strong>in</strong>clud<strong>in</strong>g the<strong>in</strong>famous "Rap<strong>to</strong>rs") which engaged <strong>in</strong> numerous non-arm's-length fraudulent transactions withCIBC <strong>to</strong> artificially <strong>in</strong>flate Enron's pr<strong>of</strong>its while conceal<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> its debt on termsso unfair <strong>to</strong> Enron that the deals would provide huge returns <strong>to</strong> the LJM2 <strong>in</strong>ves<strong>to</strong>rs. 24. Becausethe 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 exceptionalreturns as the Enron Ponzi scheme cont<strong>in</strong>ued, Enron decided that <strong>in</strong> fund<strong>in</strong>g LJM2, it would allowcerta<strong>in</strong> favored bank <strong>of</strong>ficers or the banks themselves get <strong>in</strong> on LJM2. The LJM2 partnership<strong>of</strong>fer<strong>in</strong>g memor<strong>and</strong>um by which Enron brought <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong><strong>to</strong> the partnership – which was not apublic document – conta<strong>in</strong>ed an <strong>in</strong>vitation <strong>to</strong> benefit from the self-deal<strong>in</strong>g transactions that LJM2- 11 -
would engage <strong>in</strong>. 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. 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>vestmen<strong>to</strong>pportunities" <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> CIBC knew that becauseLJM2 was go<strong>in</strong>g <strong>to</strong> engage <strong>in</strong> transactions with Enron where Enron <strong>in</strong>siders (especially Enron'sCFO Fas<strong>to</strong>w) would be on both sides <strong>of</strong> the transactions, the LJM2 partnership would beextremely 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. 11 In short, the non-public <strong>of</strong>fer<strong>in</strong>gmemor<strong>and</strong>um was an <strong>in</strong>vitation <strong>to</strong> jo<strong>in</strong> <strong>in</strong> the benefits <strong>of</strong> non-arm's-length self-deal<strong>in</strong>g transactionswith Enron – <strong>to</strong> loot Enron <strong>and</strong> share <strong>in</strong> the fruits <strong>of</strong> that loot<strong>in</strong>g. Enron's bankers <strong>and</strong> the <strong>to</strong>pexecutives <strong>of</strong> those banks – <strong>in</strong>clud<strong>in</strong>g CIBC – 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> the scheme – a sure th<strong>in</strong>g for them. 25. 12It 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 the11In 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. 24.12While 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 -
case 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 LJM2 equity money) could not complete the formation <strong>of</strong> LJM2 <strong>and</strong> raisemoney 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> enable it <strong>to</strong> do thedesperately needed year-end transactions with Enron. So, <strong>in</strong> an extraord<strong>in</strong>ary step, on 12/22/99,CIBC (or <strong>to</strong>p executives <strong>of</strong> CIBC) via CIBC Capital Corporation, even though LJM2 had not yetbeen fully formed or funded or received the m<strong>in</strong>imum required capital contribution commitmentsfrom <strong>in</strong>ves<strong>to</strong>rs, but know<strong>in</strong>g that LJM2 was go<strong>in</strong>g <strong>to</strong> be an extraord<strong>in</strong>arily lucrative <strong>in</strong>vestmentanyway, advanced $2,250,000 <strong>to</strong> "pre-fund" LJM2, i.e., many times more than their allocated shares<strong>in</strong> LJM2. 26. The reason the banks – <strong>in</strong>clud<strong>in</strong>g CIBC – 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 99 year-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 bad 4thQ 99 – which would have caused its s<strong>to</strong>ck<strong>to</strong> plunge. These vital 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.- 13 -
(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),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 non-arm's-length fraudulenttransactions with the LJM partnerships. Enron sold assets <strong>to</strong> LJM 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 3rd <strong>and</strong> 4thQ 99, Enron sold <strong>in</strong>terests<strong>in</strong> seven assets <strong>to</strong> LJM1 <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 manipulation, falsification <strong>and</strong> artificial <strong>in</strong>flation <strong>of</strong> Enron'sreported f<strong>in</strong>ancial results, while enrich<strong>in</strong>g the LJM <strong>in</strong>ves<strong>to</strong>rs, <strong>in</strong>clud<strong>in</strong>g CIBC or its <strong>to</strong>p executivesvia the loot<strong>in</strong>g <strong>of</strong> Enron. 32. 1313The 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> hide- 14 -
One "hedg<strong>in</strong>g" transaction with LJM <strong>in</strong> 6/99 <strong>in</strong>volved Rhythms NetConnections ("Rhythms")s<strong>to</strong>ck owned by Enron, <strong>to</strong> "hedge" Enron's huge ga<strong>in</strong>s <strong>in</strong> Rhythms s<strong>to</strong>ck <strong>and</strong> enable Enron <strong>to</strong>create a huge pr<strong>of</strong>it. Enron transferred its own s<strong>to</strong>ck <strong>to</strong> the SPE <strong>in</strong> exchange for a note. But ifthe SPE were required <strong>to</strong> pay Enron on the "hedge," the Enron s<strong>to</strong>ck would be the source <strong>of</strong>payment. Other "hedg<strong>in</strong>g" transactions occurred <strong>in</strong> 00 <strong>and</strong> 01 <strong>and</strong> <strong>in</strong>volved SPEs known as the"Rap<strong>to</strong>r" vehicles. These were also structures, funded pr<strong>in</strong>cipally with Enron's own s<strong>to</strong>ck, thatwere <strong>in</strong>tended <strong>to</strong> "hedge" aga<strong>in</strong>st decl<strong>in</strong>es <strong>in</strong> the value <strong>of</strong> certa<strong>in</strong> <strong>of</strong> Enron's merchant<strong>in</strong>vestments. These transactions were not economic hedges. They actually were manipulative ordeceptive devices devised <strong>to</strong> circumvent account<strong>in</strong>g rules. The economic reality was that Enronnever escaped the risk <strong>of</strong> loss, because it had provided the bulk <strong>of</strong> the capital with which the SPEswould pay Enron. Enron <strong>and</strong> Enron's banks used these contrivances <strong>and</strong> manipulative or deceptivedevices <strong>to</strong> <strong>in</strong>flate Enron's reported f<strong>in</strong>ancial results. In 99, Enron recognized <strong>in</strong>come <strong>of</strong> over $100million from the Rhythms "hedg<strong>in</strong>g" transaction. In the last two quarters <strong>of</strong> 00, Enron recognizedpre-tax earn<strong>in</strong>gs <strong>of</strong> $530 million on several transactions with the Rap<strong>to</strong>r entities out <strong>of</strong> reportedpre-tax earn<strong>in</strong>gs <strong>of</strong> $650 million. These "earn<strong>in</strong>gs" from the Rap<strong>to</strong>rs' manipulative contrivancesaccounted for more than 80% <strong>of</strong> the <strong>to</strong>tal! 33.Hedg<strong>in</strong>g Enron's <strong>in</strong>vestments with the value <strong>of</strong> Enron's s<strong>to</strong>ck created an enormous <strong>and</strong>unusual motive for the participants <strong>in</strong> the scheme <strong>to</strong> keep Enron s<strong>to</strong>ck trad<strong>in</strong>g at <strong>in</strong>flated levels. Thiswas because if the value <strong>of</strong> Enron s<strong>to</strong>ck fell, the SPEs would be unable <strong>to</strong> meet their obligations <strong>and</strong>the "hedges" would fail. This happened <strong>in</strong> late 00 <strong>and</strong> early 01. In 12/00, Enron's ga<strong>in</strong> (<strong>and</strong> theRap<strong>to</strong>rs' correspond<strong>in</strong>g net loss) on these transactions was over $500 million. Enron could recognizethese 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 ifthe Rap<strong>to</strong>rs had the capacity <strong>to</strong> make good on their debt <strong>to</strong> Enron. If they did not, Enron wouldbe required <strong>to</strong> record a "credit reserve," a loss that would defeat the very purpose <strong>of</strong> the Rap<strong>to</strong>rs,which was <strong>to</strong> shield Enron from the decl<strong>in</strong>e <strong>in</strong> value <strong>of</strong> its merchant <strong>in</strong>vestments. 34.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 York Times, 4/24/02.- 15 -
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 were 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, more <strong>and</strong> more <strong>of</strong> the s<strong>to</strong>ck issuance "triggers" would be hit, <strong>and</strong> a vicious fataldown-cycle would kick <strong>in</strong>. Therefore, Enron restructured <strong>and</strong> capitalized the LJM2-f<strong>in</strong>anced Rap<strong>to</strong>rSPEs at year-end 00 by transferr<strong>in</strong>g <strong>to</strong> them rights <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> supportEnron'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 yearend<strong>in</strong>g 12/31/00. 35.Thus, these favored <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 – like CIBC or its <strong>to</strong>p executives – actually witnesseda series <strong>of</strong> extraord<strong>in</strong>ary pay outs from the Rap<strong>to</strong>r SPEs which LJM2 controlled over the next twoyears – 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> – i.e.,the manipulative or deceptive devices – with the Rap<strong>to</strong>rs <strong>to</strong> falsify Enron's f<strong>in</strong>ancial results. Thus,the banks <strong>and</strong> bankers – like CIBC or its <strong>to</strong>p executives – who were partners <strong>in</strong> LJM2 were not onlyknow<strong>in</strong>g participants <strong>in</strong> the Enron scheme <strong>to</strong> defraud, they were economic beneficiaries <strong>of</strong> it –<strong>and</strong> <strong>of</strong> the loot<strong>in</strong>g <strong>of</strong> Enron. Had the Enron Ponzi scheme cont<strong>in</strong>ued <strong>to</strong> operate for the full life<strong>of</strong> the LJM2 partnership, Enron's banks would have achieved the stupendous returns they werepromised – measured <strong>in</strong> thous<strong>and</strong>s <strong>of</strong> percent. And these actual <strong>and</strong> potential payments fromLJM2 were on <strong>to</strong>p <strong>of</strong> the huge advisory fees, underwriter fees, <strong>in</strong>terest <strong>and</strong> loan commitment feesthese banks were already gett<strong>in</strong>g from Enron <strong>and</strong> would cont<strong>in</strong>ue <strong>to</strong> get if the Enron schemecont<strong>in</strong>ued. 31.D. Enron Energy Services ("EES")The falsification <strong>of</strong> Enron's f<strong>in</strong>ancial statements was not limited <strong>to</strong> non-arm's-lengthfraudulent partnership <strong>and</strong> SPE transactions. While Enron's Wholesale Energy bus<strong>in</strong>ess was thelargest s<strong>in</strong>gle contribu<strong>to</strong>r <strong>to</strong> its pr<strong>of</strong>its, Enron <strong>and</strong> its banks – <strong>in</strong>clud<strong>in</strong>g CIBC – 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- 16 -
– whereby Enron purportedly under<strong>to</strong>ok <strong>to</strong> manage the energy needs <strong>of</strong> corporate consumers formulti-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 bankspresented this bus<strong>in</strong>ess as achiev<strong>in</strong>g tremendous success by constantly sign<strong>in</strong>g new multi-million oreven 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.However, EES was 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 energy management contracts <strong>and</strong> "jumpstart" thisbus<strong>in</strong>ess so it could appear <strong>to</strong> obta<strong>in</strong> huge contract volumes, Enron was enter<strong>in</strong>g <strong>in</strong><strong>to</strong> EESmanagement 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 the ultimate value <strong>of</strong> these contracts <strong>and</strong>created greatly <strong>in</strong>flated current period pr<strong>of</strong>its from transactions which generated little, if any, currentperiod cash, <strong>and</strong> which would likely actually result <strong>in</strong> long-term cash out plans <strong>and</strong> losses. As aletter written <strong>in</strong> 8/01 <strong>to</strong> Enron's Board by an EES manager stated just after 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 <strong>and</strong> engag<strong>in</strong>g <strong>in</strong> trad<strong>in</strong>g access <strong>to</strong> Enron's <strong>and</strong> others' fiber opticcable capability, i.e., "Broadb<strong>and</strong> Intermediation." Enron <strong>and</strong> its banks presented both parts <strong>of</strong>- 17 -
Enron's broadb<strong>and</strong> bus<strong>in</strong>ess as poised <strong>to</strong> achieve, <strong>and</strong> later as actually achiev<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 successfully constructed, 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> trad<strong>in</strong>g bus<strong>in</strong>ess wassucceed<strong>in</strong>g <strong>and</strong> achiev<strong>in</strong>g much higher trad<strong>in</strong>g volume <strong>and</strong> revenues than expected – 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, with the help <strong>of</strong> CIBC, which purportedly <strong>in</strong>vested <strong>in</strong> the deal but secretly got a no-lossguarantee from Enron, Enron recognized an as<strong>to</strong>nish<strong>in</strong>g $110+ million pr<strong>of</strong>it on this deal <strong>in</strong> the4thQ 99 <strong>and</strong> 1stQ 00, even though the project was fail<strong>in</strong>g <strong>in</strong> its test markets because Enron did nothave the technology <strong>to</strong> deliver the product as represented – <strong>and</strong> which could never have gone forwardbecause Blockbuster did not have the legal right <strong>to</strong> deliver movies <strong>in</strong> a digital format, the only formatwhich could be utilized for VOD. 40. 14F. New PowerAnother example <strong>of</strong> how Enron <strong>and</strong> CIBC falsified Enron's reported results is the New PowerIPO <strong>in</strong> 10/00, by which Enron improperly created a $370 million pr<strong>of</strong>it <strong>in</strong> the 4thQ 00. Enroncontrolled New Power <strong>and</strong> owned millions <strong>of</strong> shares <strong>of</strong> New Power s<strong>to</strong>ck. If Enron <strong>and</strong> its bankscould take New Power public <strong>and</strong> create a trad<strong>in</strong>g market <strong>in</strong> its s<strong>to</strong>ck, Enron could recognize a pr<strong>of</strong>it14Just 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. CIBC did notforce Enron <strong>to</strong> honor its secret guarantee aga<strong>in</strong>st losses, as it knew <strong>to</strong> do so would underm<strong>in</strong>e Enron'sfragile f<strong>in</strong>ancial condition, but rather, carried it as part <strong>of</strong> its overall exposure <strong>to</strong> Enron. 41.- 18 -
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 transactionvia LJM2. In the 4thQ 00, Enron desperately needed <strong>to</strong> create pr<strong>of</strong>its <strong>to</strong> perpetuate the Ponzischeme. Enron <strong>and</strong> CIBC did the New Power IPO – 27.6 million shares at $21 per share <strong>in</strong> 10/00.Then, <strong>in</strong> a deal secretly structured with CIBC before the IPO, Enron created a phony pr<strong>of</strong>it us<strong>in</strong>g anLJM2 SPE called Hawaii 125-0. CIBC (<strong>and</strong> several other <strong>of</strong> Enron's banks) made a "loan" <strong>of</strong> $125million <strong>to</strong> Hawaii 125-0, but secretly received a "<strong>to</strong>tal return swap" guarantee <strong>to</strong> protect CIBC<strong>and</strong> the other banks aga<strong>in</strong>st any loss from Enron. Enron transferred millions <strong>of</strong> New Powerwarrants <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 simultaneously supposedly"hedged" the warrants with another entity created <strong>and</strong> controlled by Enron called "Porcup<strong>in</strong>e." Tosupposedly 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-calledhedge <strong>of</strong> the New Power warrants, but, one week later, Porcup<strong>in</strong>e paid the $30 million back <strong>to</strong> LJM2plus 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 fellsharply, as the chart below shows:30New Power Hold<strong>in</strong>gs, Inc.25Dollars Per Share20151050Oct-00Nov-00Jan-01Feb-01Apr-01May-01Jul-01Aug-01Oct-01Nov-01Jan-02Feb-02- 19 -
This 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. 15G. Enron's Access <strong>to</strong> the Capital MarketsEnron required 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 LJM2. As a result <strong>of</strong> report<strong>in</strong>g strong earn<strong>in</strong>gs, theapparent success <strong>of</strong> its bus<strong>in</strong>ess <strong>and</strong> its future earn<strong>in</strong>gs growth forecasts, Enron had unlimited access<strong>to</strong> the capital markets, borrow<strong>in</strong>g billions <strong>of</strong> dollars <strong>in</strong> the commercial paper markets <strong>and</strong> by sell<strong>in</strong>gbillions <strong>of</strong> dollars <strong>of</strong> Enron securities <strong>to</strong> the public. Enron <strong>and</strong> its bankers raised over $6 billion <strong>in</strong>new debt <strong>and</strong> equity capital for Enron or associated entities through numerous securities <strong>of</strong>fer<strong>in</strong>gs,15After LJM2 was formed, CIBC <strong>and</strong>/or its <strong>to</strong>p executives had secretly been permitted <strong>to</strong> <strong>in</strong>vest<strong>in</strong> LJM2 <strong>and</strong> was engag<strong>in</strong>g <strong>in</strong> other illicit transactions with Enron <strong>to</strong> boost its pr<strong>of</strong>its <strong>and</strong> hide itsdebts, like Braveheart <strong>and</strong> Hawaii 125-0, CIBC cont<strong>in</strong>ued <strong>to</strong> issue very positive analyst reports onEnron. Each <strong>of</strong> these reports 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 did not change after CIBC <strong>and</strong>/or its <strong>to</strong>p executives became huge<strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 or engaged <strong>in</strong>, f<strong>in</strong>anced or facilitated other illicit transactions with Enron, itscontrolled partnerships or their SPEs <strong>to</strong> boost Enron's reported pr<strong>of</strong>its <strong>and</strong>/or hide billions <strong>of</strong>dollars <strong>of</strong> debt. The failure <strong>to</strong> disclose the LJM2 <strong>in</strong>vestments <strong>of</strong> these banks <strong>and</strong>/or their <strong>to</strong>pexecutives or the banks' other transactions with Enron <strong>to</strong> boost its pr<strong>of</strong>its or enable it <strong>to</strong> hide debt<strong>and</strong> made their "boilerplate" disclosures false <strong>and</strong> mislead<strong>in</strong>g <strong>and</strong> concealed from the market thevery significant <strong>and</strong> serious conflict <strong>of</strong> <strong>in</strong>terests between Enron <strong>and</strong> the banks which they knewwould have cast serious doubts on the objectivity <strong>and</strong> honesty <strong>of</strong> those banks' analyst reports <strong>and</strong>disclosed that the banks or their 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. 29.- 20 -
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 CIBC are shown below (48):Banks NamedAs DefendantsCS First Bos<strong>to</strong>nLehman BrothersMerrill LynchCIBCJP MorganBank AmericaJP MorganCS First Bos<strong>to</strong>nLehman BrothersMerrill LynchCIBCCitiGroupLehman BrothersBank AmericaCIBCENRON SECURITIES UNDERWRITINGSDate <strong>of</strong>Offer<strong>in</strong>gSecurity Sold05/98 35 million shares <strong>of</strong> common s<strong>to</strong>ckat $25 per share rais<strong>in</strong>g $850 million forEnron02/99 27.6 million shares <strong>of</strong> common s<strong>to</strong>ck at$31.34 rais<strong>in</strong>g $870 million for Enron05/19/99 $500,000,0007.375% Notes due 5/15/2019Some <strong>of</strong> the <strong>of</strong>fer<strong>in</strong>gs <strong>of</strong> the associated entities <strong>in</strong>volv<strong>in</strong>g CIBC are shown below (49):CS First Bos<strong>to</strong>nCitiGroupCIBCCS First Bos<strong>to</strong>nDeutsche BankBank AmericaCIBCJP MorganBanks NamedAs DefendantsENRON-RELATED SECURITIES UNDERWRITINGSH. Late 00/Early 01 Prop-UpDate <strong>of</strong>Offer<strong>in</strong>gSecurity Sold10/00 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 NotesIn 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 – <strong>in</strong>clud<strong>in</strong>g CIBC – assured <strong>in</strong>ves<strong>to</strong>rs <strong>of</strong> thecorrectness <strong>of</strong> Enron's account<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>- 21 -
this <strong>in</strong>creas<strong>in</strong>g controversy, 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 putpressure on Enron'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 as they 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 byLJM2 would be triggered, which would require Enron <strong>to</strong> issue over 100 million shares <strong>of</strong> itscommon 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> theLJM2-f<strong>in</strong>anced Rap<strong>to</strong>r SPEs, which would have been catastrophic <strong>and</strong> exposed the scheme. Ratherthan take that loss <strong>and</strong> face these consequences, Enron <strong>and</strong> certa<strong>in</strong> <strong>of</strong> Enron's banks "restructured"the LJM2-f<strong>in</strong>anced Rap<strong>to</strong>r vehicles by transferr<strong>in</strong>g more than $800 million <strong>of</strong> contracts <strong>to</strong> receiveEnron's own s<strong>to</strong>ck <strong>to</strong> them just before quarter-end, which permitted the participants <strong>in</strong> thescheme <strong>to</strong> conceal substantial losses <strong>in</strong> 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> allowed 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>gCIBC – 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.I. The Impend<strong>in</strong>g CollapseBy the Summer <strong>of</strong> 01, Enron realized that it would not be able <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> susta<strong>in</strong> theillusion <strong>of</strong> strong pr<strong>of</strong>itable growth <strong>and</strong> that it would have <strong>to</strong> take large write-<strong>of</strong>fs <strong>in</strong> the second half- 22 -
<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> the SPEs 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.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 CIBC – 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 for personalreasons <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's f<strong>in</strong>ancialcondition "had never been stronger" <strong>and</strong> its "future had never been brighter." They said there was"noth<strong>in</strong>g <strong>to</strong> disclose," Enron's "numbers look good," there were "no problems" or "account<strong>in</strong>gissues." 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.J. The EndBy 8/01, <strong>in</strong>side Enron management employees were compla<strong>in</strong><strong>in</strong>g <strong>to</strong> Enron's Board that thefraud at Enron was so widespread it was out <strong>of</strong> control. In 8/01, two employees compla<strong>in</strong>ed <strong>to</strong> theBoard (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 streetthat 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....- 23 -
[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'tclose 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....- 24 -
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 LJM participants or its 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 the SPEaccount<strong>in</strong>g rules <strong>and</strong> – because JEDI's non-consolidation depended on Chewco's status – neitherdid 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):- 25 -
ENRON ACCOUNTING RESTATEMENTS1997 1998 1999 2000Recurr<strong>in</strong>g Net Income $ 96,000,000 $113,000,000 $250,000,000 $ 132,000,000Amount <strong>of</strong>OverstatementDebtAmount <strong>of</strong>UnderstatementShareholders' EquityAmount <strong>of</strong>Overstatement$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, LJM1 <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>to</strong> conceal from the market very large losses result<strong>in</strong>g from Enron'smerchant <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 that thirdparty was simply an entity <strong>in</strong> which only Enron had a substantial economic stake. The Rap<strong>to</strong>rstransactions alone resulted <strong>in</strong> Enron report<strong>in</strong>g earn<strong>in</strong>gs from the 3rdQ 00 through the 3rdQ 01that were almost $1 billion higher than should have been reported! 62.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.- 26 -
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, enable 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 presented below:- 27 -
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 CIBC'S FACTUAL INVOLVEMENT AND LEGALLIABILITYCIBC had an extensive <strong>and</strong> extremely close relationship with Enron. CIBC provided bothcommercial 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> fund several<strong>of</strong> Enron's secretly controlled partnerships <strong>and</strong> illicit transactions with its SPEs <strong>and</strong> helped Enronfalsify its 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 thatshould have been on Enron's balance sheet. Also, CIBC or <strong>to</strong>p executives <strong>of</strong> CIBC were permitted<strong>to</strong> personally <strong>in</strong>vest at least $15 million <strong>in</strong> Enron's lucrative LJM2 partnership as a reward <strong>to</strong> themfor orchestrat<strong>in</strong>g CIBC's participation <strong>in</strong> this fraud, while Enron secretly paid CIBC grosslyexcessive <strong>in</strong>terest rates on billions <strong>of</strong> dollars <strong>of</strong> concealed/disguised loans. CIBC also sold over $2.3billion <strong>in</strong> Enron <strong>and</strong> Enron-related securities <strong>to</strong> the public <strong>and</strong> extended $4.2 billion <strong>in</strong> loans orlend<strong>in</strong>g commitments <strong>to</strong> Enron. At the same time, CIBC's securities analysts were issu<strong>in</strong>gextremely 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>esssuccess, 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> revenuegrowth. In return for CIBC's participation <strong>in</strong> the 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, while CIBC or its <strong>to</strong>p executives pocketed the lush returns 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. 715-716, 722.CIBC acted as an underwriter <strong>in</strong> sell<strong>in</strong>g $500 million <strong>of</strong> Enron 7.375% notes due 5/15/2019pursuant <strong>to</strong> a false <strong>and</strong> mislead<strong>in</strong>g 5/99 Registration Statement. 723, 1006. This exposes CIBC<strong>to</strong> §11 liability under the 1933 Act – non-fraud liability – under which it is prima facie liable <strong>and</strong>can avoid liability only by bear<strong>in</strong>g its burden <strong>of</strong> pro<strong>of</strong> that it had, "after reasonable <strong>in</strong>vestigation,reasonable ground <strong>to</strong> believe <strong>and</strong> did believe ... that the statements there<strong>in</strong> were true <strong>and</strong> that therewas no omission <strong>to</strong> state a material fact required <strong>to</strong> be stated there<strong>in</strong> or necessary <strong>to</strong> make thestatements there<strong>in</strong> not mislead<strong>in</strong>g," i.e., the underwriter's so-called "due diligence" defense. 15U.S.C. §77k(a)(5), (b)(3).CIBC also made false <strong>and</strong> mislead<strong>in</strong>g statements <strong>in</strong> the 2/99 Registration Statement for thesale <strong>of</strong> 27.6 million shares <strong>of</strong> Enron s<strong>to</strong>ck at $31.34, <strong>in</strong> the 5/99 Registration Statement for the sale- 29 -
<strong>of</strong> $500 million <strong>of</strong> Enron 7.375% notes, <strong>in</strong> the 10/00 New Power Registration Statement for the sale<strong>of</strong> 27.6 million shares <strong>of</strong> New Power s<strong>to</strong>ck <strong>and</strong> <strong>in</strong> 15 analysts' reports on Enron it issued dur<strong>in</strong>g theClass Period, which helped <strong>to</strong> artificially <strong>in</strong>flate the trad<strong>in</strong>g prices <strong>of</strong> Enron's securities. 132, 148,161, 176, 183, 194, 199, 207, 230, 251, 269, 323, 334, 349, 372, 718, 721, 724. Such falsestatements are expressly made illegal by the text <strong>of</strong> Rule 10b-5, issued pursuant <strong>to</strong> §10(b) <strong>of</strong> the 1934Act, which prohibits "any untrue statement <strong>of</strong> a material fact" by "any person" <strong>in</strong> connection withsecurities transactions.CIBC's false statements <strong>in</strong> the Registration Statements used for the sale <strong>of</strong> $500 million <strong>of</strong>Enron 7.375% notes, the 27.6 million shares <strong>of</strong> Enron s<strong>to</strong>ck <strong>and</strong> for the New Power IPO <strong>and</strong> <strong>in</strong> its15 analysts' reports were also part <strong>of</strong> a wider pattern <strong>of</strong> misconduct by CIBC <strong>in</strong> which CIBCemployed 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,provid<strong>in</strong>g millions <strong>to</strong> f<strong>in</strong>ance Enron's secretly controlled partnerships <strong>and</strong> illicit transactions withassociated SPEs <strong>to</strong> falsify Enron's reported f<strong>in</strong>ancial condition <strong>and</strong> pr<strong>of</strong>its, all <strong>of</strong> which operated <strong>to</strong>artificially <strong>in</strong>flate the prices <strong>of</strong> Enron's publicly traded securities. This conduct is also expresslyprohibited by the language <strong>of</strong> §10(b) <strong>and</strong> Rule 10b-5. 16 CIBC's sale <strong>of</strong> Enron <strong>and</strong> Enron-relatedsecurities, its commercial loans <strong>to</strong> Enron <strong>and</strong> its analysts' reports on Enron are shown on thefollow<strong>in</strong>g graphic chart:16False statements <strong>in</strong> a Registration Statement can create liability under both 1933 Act §11 <strong>and</strong>1934 Act §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.- 30 -
Dollars Per Share100908070605040Total Shares Sold By Defendants: 20,788,957 sharesDefendants' Insider Trad<strong>in</strong>g Proceeds: $1,190,479,472Summary <strong>of</strong> CIBC InvolvementPrefunder ($2.25 million)/Inves<strong>to</strong>r($15 million) <strong>in</strong> LJM2 entity used <strong>to</strong>create hundreds <strong>of</strong> millions <strong>of</strong> boguspr<strong>of</strong>its <strong>and</strong> hide billions <strong>in</strong> debts <strong>and</strong>loot EnronNew Power IPO <strong>and</strong> Hawaii 125-0deal create $370 million <strong>in</strong> boguspr<strong>of</strong>its for EnronIssued 15 false <strong>and</strong> mislead<strong>in</strong>ganalyst reports on Enron§11 liability for 5/99 7.375% notesales4 securities <strong>of</strong>fer<strong>in</strong>gs rais<strong>in</strong>g $2.3billion for Enron <strong>and</strong> related entitiesvia false <strong>and</strong> mislead<strong>in</strong>g registrationstatements$4.2 billion <strong>in</strong> loans <strong>and</strong>commitments <strong>to</strong> EnronBraveheart transaction creat<strong>in</strong>g$110 million <strong>in</strong> bogus pr<strong>of</strong>its forEnron10/14/983d Q 98 results better thanestimates. Growthspearheaded by WEOS. EEScontracts grow<strong>in</strong>g. EESundiscounted revenues shouldexceed $3 billion by year end<strong>and</strong> be pr<strong>of</strong>itable by 2d half <strong>of</strong>99. $12 billion backlog.Higher marg<strong>in</strong> EES contractsbe<strong>in</strong>g negotiated.10/98-2/99Insiders sell2,253,958 sharesfor $67+ million.1/25/99After setbacks <strong>of</strong> 95-97,Enron has re-emerged as afavorite. EES contractsgrow<strong>in</strong>g. Future revenuesshould exceed $3 billion.Several higher growth fronts.3/99-4/99Insiders sell2,021,640 sharesfor $71+ million.7/14/992nd Q 99 results aboveestimates. Longer termearn<strong>in</strong>g power should build.5/99-7/99Insiders sell794,934 sharesfor $30+ million.Enron Timel<strong>in</strong>e -- CIBC Underwrit<strong>in</strong>gs/Loans/Analyst Reports4/12/00 Buy Rat<strong>in</strong>g1st Q 00 EPS above estimates. EES akey growth area. $3.7 billion newcontracts -- ahead <strong>of</strong> expectations.Forecasts 00/01 EPS $1.38/$1.58.1/21/00 Buy Rat<strong>in</strong>gRais<strong>in</strong>g price target <strong>to</strong> due <strong>to</strong> further clarification <strong>of</strong>broadb<strong>and</strong> strategy <strong>and</strong> energy bus<strong>in</strong>ess growth --<strong>to</strong> cont<strong>in</strong>ue. Forecasts 00/01 EPS $1.35/$1.53.1/18/00 Buy Rat<strong>in</strong>gEarn<strong>in</strong>gs up 29% for 4th Q 99 <strong>and</strong> 18% for year.Improved results were driven by ga<strong>in</strong>s at allsegments. EES turned pr<strong>of</strong>itable. Forecasts00/01 EPS $1.35/$1.53.Enron1/6/00 Buy Rat<strong>in</strong>gMajor <strong>in</strong>itatives mov<strong>in</strong>g ahead.Push <strong>in</strong><strong>to</strong> broadb<strong>and</strong> hassignificant value potential. Enronshares <strong>to</strong> susta<strong>in</strong> solidmomentum. Forecasts 00/01 EPS$1.35/$1.53.9/99-12/99Insiders sell 972,588shares for $39+ million.1/00-3/00Insiders sell2,940,125 sharesfor $208+ million.7/31/98 - 3/7/027/24/00 Buy Rat<strong>in</strong>gStrong growth prospects <strong>in</strong> WEOS/EES <strong>and</strong> highlong-term potential <strong>of</strong> broadb<strong>and</strong> strategy. EPSris<strong>in</strong>g. Full scale VOD <strong>in</strong> 01. Blockbuster VODdeal strong endorsement <strong>of</strong> Enron's technologicalcapabilities. Full-scale rollout expected <strong>in</strong> 01.Forecasts 00/01 EPS $1.42/$1.62.4/00-5/00Insiders sell3,552,044shares for$266+ million.7/00 Announced Blockbuster/Braveheart VOD jo<strong>in</strong>t venture.7/00-9/00Insiders sell1,239,388 sharesfor $108+ million. 10/00-12/00Insiders sell1,556,882 sharesfor $111+ million.10/00 New Power IPO - 27.6million shares @ $21 via CIBCenables Enron <strong>to</strong> create $370million bogus pr<strong>of</strong>it.10/19/00 Buy Rat<strong>in</strong>g$95 price target. Strong 3d Q 00 with strong ga<strong>in</strong>s <strong>in</strong>EES <strong>and</strong> WEOS. EPS ahead <strong>of</strong> estimates. EESreported $30 million pretax <strong>in</strong>come <strong>and</strong> $4.1 billion <strong>in</strong>contracts this quarter. Forecasts 00/01/02 EPS$1.42/$1.65/$1.95.1/01-3/01Insiders sell1,136,548 sharesfor more than$82+ million.4/19/01 Buy Rat<strong>in</strong>g1st Q 01 results. Increases EPS forecasts. EES EBIT$40 million. Revenues more than doubled. EBS didmore transactions <strong>in</strong> quarter than <strong>in</strong> the wholeprevious year. Forecasts 01/02 EPS $1.78/ $2.05.3/01-4/01Insiders sell465,329 sharesfor $30+ million.7/01 $1 billion Marl<strong>in</strong>Water notes via CIBC.4/01-7/01Insiders sell2,807,803 shares for$143+ million.CIBC Analyst Report IssuedEnron S<strong>to</strong>ck Issuance Price Trigger7/13/01 Buy Rat<strong>in</strong>g2nd Q 01 solid performance -- strong results.Increases EPS forecasts. Managementconfident <strong>in</strong> prospects for WEOS <strong>and</strong> EES.Forecasts 01/02 EPS $1.80/$2.15.8/01-9/01Insiders sell685,667 sharesfor $24+ million.8/01 $3 billioncommercial paperbackup credit facilityfor Enron.40030020010/19/98 = 1003020107/98 $250 millionloan <strong>to</strong> Enronsubsidiary byCIBC.9/98 $1 billioncredit facility forEnron <strong>to</strong> back upcommercial paper.2/99 Enron sells 27.6 millionshares @ $31.34 via CIBC,rais<strong>in</strong>g $870 million.5/99 Enronsells $500million 7.375%notes via CIBC.4/14/991st Q 99 results above estimates.Improved WEOS performance. Strengthdue <strong>to</strong> WEOS, longer term earn<strong>in</strong>g power<strong>to</strong> build. Share price premium <strong>to</strong> hold.Forecasts 00/01 EPS $1.325/$1.475.10/7/99 Buy Rat<strong>in</strong>gAs management cont<strong>in</strong>ues <strong>to</strong>build on core strengths,expect the share pricepremium <strong>to</strong> hold. EEScontracts grow<strong>in</strong>g -- $12billion by year end. Build<strong>in</strong>gEES with notable cus<strong>to</strong>mers.Forecasts 00/01 EPS$1.35/$1.53.10/13/99 Buy Rat<strong>in</strong>gEES bus<strong>in</strong>ess large <strong>and</strong>improv<strong>in</strong>g. EES <strong>to</strong> meet orexceed target <strong>of</strong> $8 billion <strong>in</strong>new contracts <strong>in</strong> 99. EESfirmly on track <strong>to</strong> boostEnron's earn<strong>in</strong>gs. Forecasts00/01 EPS $1.35/$1/53.Peer Index8/15/01 Buy Rat<strong>in</strong>gSkill<strong>in</strong>g departure not related <strong>to</strong> Enron current orexpected performance or f<strong>in</strong>ancial or operationalperformance. Forecasts 01/02 EPS $1.80/$2.15.10/17/01 Buy Rat<strong>in</strong>gEnron meets expectations. WEOS performedsolidly. Increase <strong>in</strong> operat<strong>in</strong>g EPS <strong>of</strong> 26%.Forecasts 01/02 EPS $1.80/$2.15.10/01Insiders sell362,051shares for $6+million.12/01Enron bankrupt.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); see also Aaron v. SEC,446 U.S. 680, 696 n.13 (1980). Thus, scheme liability is authorized by the text <strong>of</strong> §10(b). Rule10b-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 falsestatements, makes it unlawful for any person "directly or <strong>in</strong>directly" <strong>to</strong> employ "any device, 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>ess which 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.; Super<strong>in</strong>tendent <strong>of</strong> Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 11 n.7 (1971) ("'[Wedo 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>volvethe type <strong>of</strong> fraud that is 'usually associated with the sale or purchase <strong>of</strong> securities.' We believethat §10 (b) <strong>and</strong> Rule 10b-5 prohibit all fraudulent schemes <strong>in</strong> connection with the purchase orsale <strong>of</strong> securities, whether the artifices employed <strong>in</strong>volve a garden type variety <strong>of</strong> fraud, or presenta unique 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)). As statedby the Second Circuit: "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.'"- 32 -
Competitive Assocs., Inc. v. Laventhol, Krekste<strong>in</strong>, Horwath & Horwath, 516 F.2d 811, 814 (2d Cir.1975).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 Offer<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 Offer<strong>in</strong>g Circular was only a part: "Rather thanconta<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 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 alleg<strong>in</strong>g manipulations <strong>of</strong>reported f<strong>in</strong>ancial results by two public companies properly alleged a scheme <strong>to</strong> defraud or course<strong>of</strong> bus<strong>in</strong>ess operat<strong>in</strong>g as a fraud as the effect was <strong>to</strong> defraud certa<strong>in</strong> purchasers <strong>of</strong> Docutel securities<strong>in</strong> violation <strong>of</strong> Rule 10b-5(a) <strong>and</strong> (c)).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 <strong>and</strong> abett<strong>in</strong>g liability does not mean that secondary ac<strong>to</strong>rs <strong>in</strong> the securities marketsare always 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 17 or makes a material misstatement (or omission)on which a purchaser ... relies 18 may be liable as a primary viola<strong>to</strong>r under 10b-5.... In any17As po<strong>in</strong>ted out earlier, the Court has previously held that §10(b)'s language "any manipulativeor deceptive device or contrivance" <strong>in</strong>cludes a "scheme <strong>to</strong> deceive" or "scheme, plan or artifice."Ernst & Ernst, 425 U.S. at 199 n.20.18Because 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.- 33 -
complex securities fraud, moreover, there are likely <strong>to</strong> be multiple viola<strong>to</strong>rs." 511 U.S. at 191. Ascheme <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 agroup <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 Sec., 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." 511 U.S. at 191. However, neither the words aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g nor any other languageencompass<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 "the text <strong>of</strong> the1934 Act does not itself reach those who aid <strong>and</strong> abet a §10(b) violation [<strong>and</strong>] that conclusionresolves the case." Id. at 177. The Central Bank pla<strong>in</strong>tiffs did not, as the pla<strong>in</strong>tiffs here do, pleador pursue recovery under the theory that the bank defendant – here CIBC – (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., analysts' 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 made mislead<strong>in</strong>g statements because the Court later rejected that argument <strong>in</strong> UnitedStates v. O'Hagan, 521 U.S. 642 (1997). The Eighth Circuit had held that, under Central Bank,"§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 because§10(b) prohibits "any manipulative or deceptive device or contrivance" <strong>in</strong> contravention <strong>of</strong> SEC1132 (2001); F<strong>in</strong>e v. Am. Solar K<strong>in</strong>g Corp., 919 F.2d 290, 298 (5th Cir. 1990).- 34 -
ules <strong>and</strong> thus reaches "any deceptive device," whether or not the defendant spoke. Id. at 653.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 §10(b)/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:There certa<strong>in</strong>ly was an "act" or "practice" with<strong>in</strong> the mean<strong>in</strong>g <strong>of</strong> Rule10b-5 which operated as "a fraud or deceit" on Manhattan, the seller <strong>of</strong> theGovernment bonds.Id. at 9 (footnote omitted).This Court has repeatedly stated:liable.A defendant need not have made a false or mislead<strong>in</strong>g statement <strong>to</strong> beL<strong>and</strong>ry's, slip op. at 9 n.12; In re Waste Mgmt. Inc. Sec. Litig., No. H-99-2183, slip op. at 75 (S.D.Tex. Aug. 16, 2001); 19 In re Sec. Litig. BMC S<strong>of</strong>tware, Inc., 183 F. Supp. 2d 860, 869 (S.D. Tex.2001). So while false statements are not <strong>in</strong>dispensable <strong>to</strong> §10(b)/Rule 10b-5 liability, here, CIBCallegedly made numerous false or mislead<strong>in</strong>g statements <strong>in</strong> three Registration Statements <strong>and</strong> <strong>in</strong> 15analysts' reports. Thus, CIBC is wrong <strong>in</strong> assert<strong>in</strong>g that there is a bright l<strong>in</strong>e test for §10(b)/Rule10b-5 liability – i.e., you must make a statement. But even if such a rule existed, the CC would stillstate valid claims aga<strong>in</strong>st CIBC because its own false statements are alleged.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.1.19Due <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 Management, <strong>and</strong> the fact that theCourt has access <strong>to</strong> them, they have not been attached <strong>to</strong> this brief.- 35 -
• "[N]either the SEC nor this Court has ever held that there must be a misrepresentation about the value <strong>of</strong> a particular security" <strong>to</strong> violate §10(b). Id. at *13. 20• 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> 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 533. 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, CIBC did it all. CIBC made false statements <strong>in</strong> Registration Statements where CIBCsold Enron <strong>and</strong> Enron-related securities <strong>and</strong> <strong>in</strong> CIBC's analysts' reports on Enron. And CIBCemployed specified acts, manipulative or deceptive devices <strong>and</strong> contrivances <strong>to</strong> help falsify Enron'sf<strong>in</strong>ances <strong>and</strong> which were essential <strong>to</strong> the ongo<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 from20To 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 -
its <strong>in</strong>vestment <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess – CIBC facilitated, furthered <strong>and</strong>participated <strong>in</strong> the fraud. All <strong>of</strong> these activities directly contravened prohibitions <strong>of</strong> the 1933 <strong>and</strong>1934 Acts. CIBC was not an unwitt<strong>in</strong>g victim <strong>of</strong> the fraud <strong>in</strong>volv<strong>in</strong>g Enron – it was an activeperpetra<strong>to</strong>r <strong>of</strong> <strong>and</strong> participant <strong>in</strong> that fraud. Thus, CIBC's alleged liability is "primary" <strong>and</strong> not"secondary."Not only does the CC assert viable legal theories <strong>of</strong> recovery aga<strong>in</strong>st CIBC under the 1933<strong>and</strong> 1934 Acts, it also pleads <strong>in</strong> detail why the statements made by CIBC were false when made <strong>and</strong>why CIBC knew or recklessly disregarded that those statements were false, thus satisfy<strong>in</strong>g the twoprongedplead<strong>in</strong>g st<strong>and</strong>ard, i.e., "falsity" <strong>and</strong> "scienter" <strong>of</strong> the 95 Act as applicable <strong>to</strong> the 1934 Act.15 U.S.C. §78u-4.The Registration Statements CIBC used <strong>to</strong> sell 27.6 million shares <strong>of</strong> Enron s<strong>to</strong>ck at $31.34<strong>in</strong> 2/99 <strong>and</strong> $500 million <strong>in</strong> 7.375% notes <strong>in</strong> 5/99 <strong>and</strong> 27.6 million shares <strong>of</strong> New Power s<strong>to</strong>ck <strong>in</strong> the10/00 New Power IPO conta<strong>in</strong>ed Enron's false annual 97, 98 <strong>and</strong> 99, <strong>in</strong>terim 99 f<strong>in</strong>ancial results <strong>and</strong>false statements concern<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>ancial risk 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. See <strong>in</strong>fra at 95-96. The 15 CIBC analysts' reports on Enron issuedbetween 10/98-10/01 also conta<strong>in</strong>ed false statements about Enron's f<strong>in</strong>ancial results <strong>and</strong> f<strong>in</strong>ancialcondition <strong>and</strong> the success <strong>of</strong> Enron's EES bus<strong>in</strong>ess, Enron's Broadb<strong>and</strong> network <strong>and</strong> EBS bus<strong>in</strong>ess.See <strong>in</strong>fra at 77-94. Thus, the allegedly false statements made by CIBC are quoted, specified by date,<strong>and</strong> the reasons the statements were false when made are pleaded, satisfy<strong>in</strong>g the 95 Act's "falsity"plead<strong>in</strong>g requirement. See id.CIBC's scienter, i.e., its "required state <strong>of</strong> m<strong>in</strong>d" is also well-pleaded. 21 The CC expla<strong>in</strong>show, due <strong>to</strong> the close <strong>in</strong>volvement <strong>of</strong> CIBC <strong>to</strong>p executives <strong>and</strong> commercial <strong>and</strong> <strong>in</strong>vestment bankerswith Enron, <strong>in</strong> lend<strong>in</strong>g, deal-mak<strong>in</strong>g <strong>and</strong> other activities, CIBC knew <strong>of</strong> the falsity <strong>of</strong> the statementsit was mak<strong>in</strong>g <strong>in</strong> Registration Statements <strong>and</strong> analysts' reports concern<strong>in</strong>g Enron. See <strong>in</strong>fra at 77-94.The CC also details numerous specific fraudulent Enron transactions <strong>in</strong>volv<strong>in</strong>g CIBC (as participant21Scienter is only required for the 1934 Act claims. CIBC's 1933 Act liability requires noshow<strong>in</strong>g <strong>of</strong> fraud, <strong>in</strong>tent or knowledge. 15 U.S.C. §77k; L<strong>and</strong>ry's, slip op. at 11 n.13, 65.- 37 -
or f<strong>in</strong>ancier) which were <strong>in</strong>tentionally deceptive acts or manipulative or deceptive contrivances –falsify<strong>in</strong>g Enron's reported f<strong>in</strong>ancial results <strong>and</strong> f<strong>in</strong>ancial condition <strong>and</strong> mak<strong>in</strong>g Enron's bus<strong>in</strong>essappear <strong>to</strong> be successful when it was not. These <strong>in</strong>clude:• 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 $2.25million advanced by CIBC (via CIBC Capital Corp.) which enabled LJM2 <strong>to</strong> fundfour critical non-arm's-length fraudulent year-end 99 deals with Enron <strong>to</strong> <strong>in</strong>flateEnron's 99 results – generat<strong>in</strong>g false pr<strong>of</strong>its while hid<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong>dollars <strong>of</strong> debt. 26-29, 881-882.• Dur<strong>in</strong>g 00-01, CIBC ultimately <strong>in</strong>vested $15 million <strong>in</strong> LJM2 <strong>to</strong> help fund LJM2,which enabled LJM2 <strong>to</strong> do numerous non-arm's-length fraudulent transactions withEnron <strong>to</strong> artificially boost Enron's pr<strong>of</strong>its dur<strong>in</strong>g 99-01, while hid<strong>in</strong>g billions <strong>of</strong>dollars <strong>of</strong> debt that should have been reported on Enron's balance sheet while CIBCpocketed the fruits <strong>of</strong> those non-arm's-length fraudulent transactions with Enron, i.e.,the loot<strong>in</strong>g <strong>of</strong> Enron.• CIBC's bogus Braveheart deal with Enron <strong>to</strong> create a controlled SPE <strong>to</strong> implementthe Blockbuster/Enron VOD jo<strong>in</strong>t venture, which enabled Enron <strong>to</strong> create <strong>and</strong> report$110 million <strong>in</strong> bogus pr<strong>of</strong>its <strong>in</strong> the 4thQ 00 <strong>and</strong> 1stQ 01.• CIBC's bogus Hawaii 125-0 deal with Enron <strong>in</strong> connection with the New Power IPO,whereby a CIBC-f<strong>in</strong>anced Enron/SPE deal created a non-arm's-length hedg<strong>in</strong>g deal<strong>to</strong> generate a fictitious $370 million pr<strong>of</strong>it for Enron <strong>in</strong> the 4thQ 00.F<strong>in</strong>ally, <strong>in</strong> addition <strong>to</strong> CIBC's 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 CIBC's motive <strong>and</strong> opportunity 22 <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. CIBC was reap<strong>in</strong>g hugeamounts <strong>of</strong> money from the scheme. Also, CIBC was be<strong>in</strong>g rewarded by be<strong>in</strong>g allowed <strong>to</strong> <strong>in</strong>vest$15 million <strong>in</strong> LJM2 <strong>and</strong> thus reap<strong>in</strong>g huge returns as secret <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> the LJM2 partnership,unusually pr<strong>of</strong>itable returns generated by that entity's illicit deals with Enron SPEs – transactionsCIBC knew would collapse if Enron's s<strong>to</strong>ck fell through the equity issuance trigger pricesembedded <strong>in</strong> those LJM2/SPE deals. 732. 2322By sell<strong>in</strong>g Enron <strong>and</strong> Enron-related securities via SEC filed Registration Statements <strong>and</strong>issu<strong>in</strong>g analysts' 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, CIBC had plenty <strong>of</strong> opportunity <strong>to</strong> mislead <strong>in</strong>ves<strong>to</strong>rs <strong>and</strong> advance thefraud as well.23The 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.- 38 -
CIBC had powerful <strong>in</strong>centives <strong>to</strong> take steps <strong>to</strong> not only keep Enron solvent, but <strong>to</strong> ma<strong>in</strong>ta<strong>in</strong>its coveted <strong>in</strong>vestment grade credit rat<strong>in</strong>g which provided Enron access <strong>to</strong> the commercial papermarket. CIBC had made <strong>and</strong> was mak<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars from the fraudulent scheme<strong>in</strong>volv<strong>in</strong>g Enron <strong>and</strong> Enron's fraudulent course <strong>of</strong> bus<strong>in</strong>ess <strong>and</strong> s<strong>to</strong>od <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> make hundreds<strong>of</strong> millions more if it could be susta<strong>in</strong>ed – <strong>and</strong> <strong>to</strong> lose a bundle if the scheme was discovered,unraveled or came <strong>to</strong> an end. CIBC had plenty <strong>of</strong> motive <strong>to</strong> defraud Enron's <strong>in</strong>ves<strong>to</strong>rs.Thus, as <strong>to</strong> CIBC, the CC pleads 1933 Act §11 non-fraud liability <strong>and</strong> 1934 Act "primaryliability" based on legal theories <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'splead<strong>in</strong>g st<strong>and</strong>ard applicable <strong>to</strong> the 1934 Act.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. Allegations that the <strong>in</strong>vestment bankdefendants had issued analysts' reports know<strong>in</strong>g them <strong>to</strong> be false due <strong>to</strong> their "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. Noteholders Sec. Litig., 174F. 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>g Livent <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-5 claims); Murphy v. Hollywood Entm't Corp., No. 95-1926-MA, 1996 U.S. Dist.LEXIS 22207 (D. Or. May 9, 1996) <strong>and</strong> Flecker v. Hollywood Entm't Corp., No. 95-1926-MA, 1997U.S. Dist. LEXIS 5329, at *25 (D. Or. Feb. 12, 1997) (Refused <strong>to</strong> dismiss a compla<strong>in</strong>t or grantsummary judgment <strong>to</strong> banks, stat<strong>in</strong>g that their "roles as analysts, <strong>in</strong>vestment bankers <strong>and</strong> bus<strong>in</strong>essadvisors 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 aAs 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,fail<strong>in</strong>g <strong>to</strong> elim<strong>in</strong>ate additional hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> phony pr<strong>of</strong>its as Enron, Andersen,V<strong>in</strong>son & Elk<strong>in</strong>s <strong>and</strong> the banks were still try<strong>in</strong>g <strong>to</strong> keep Enron afloat <strong>and</strong> try<strong>in</strong>g <strong>to</strong> conceal howextensive the fraud had really been. 63, 850-856.- 39 -
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 false reports on company whichmade exaggerated predictions while ignor<strong>in</strong>g "red flags" adequately pleaded recklessness);McNamara v. Bre-X-M<strong>in</strong>erals Ltd., No. 5:97-CV-159, 2001 U.S. Dist. LEXIS 4571, at *166 (E.D.Tex. Mar. 30, 2001) (Denied 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)/Rule 10b-5 by help<strong>in</strong>g <strong>to</strong> structure fraudulent bus<strong>in</strong>ess transactions,act<strong>in</strong>g as 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."). See alsoSEC 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,where compla<strong>in</strong>t properly alleged defendant <strong>to</strong> be primary viola<strong>to</strong>r because he "'participated <strong>in</strong> thefraudulent scheme,'" not<strong>in</strong>g "lawyers, accountants, <strong>and</strong> banks who engage <strong>in</strong> fraudulent ordeceptive practices at their client's direction [are] a primary viola<strong>to</strong>r"); Scholnick v. Cont<strong>in</strong>entalBank, 752 F. Supp. 1317, 1323 & n.9 (E.D. Mich. 1990) ("bank ... may still be held liable under Rule10b-5(a) <strong>and</strong> 10b-5(c) as a participant <strong>in</strong> the allegedly fraudulent scheme" <strong>and</strong> "allegations thatCont<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 fromsituation 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>g transaction'"). The CC<strong>in</strong> this action pleads more wrongful conduct by CIBC vis-à-vis the fraudulent scheme <strong>in</strong>volv<strong>in</strong>gEnron <strong>and</strong> with greater specificity than was pleaded <strong>in</strong> any <strong>of</strong> the above cases where compla<strong>in</strong>tsnam<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, newsecurities 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, thescheme ultimately collapses <strong>and</strong> their participation is disclosed. But participants <strong>in</strong> fraudulentschemes – especially Ponzi securities 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 it cont<strong>in</strong>ues. The- 40 -
fact that such complex schemes may ultimately fail – <strong>and</strong> the perpetra<strong>to</strong>rs may then suffer 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 unlawfulconduct 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> a situation likeEnron – the people <strong>and</strong> pension funds who <strong>in</strong>vested billions <strong>of</strong> dollars <strong>to</strong> purchase Enron securitiesat <strong>in</strong>flated prices that are left hold<strong>in</strong>g the bag. They are the ones who are truly damaged. And thefederal securities laws are 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: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>rs can recover their losses without hav<strong>in</strong>g <strong>to</strong> rely upon government action.Such private lawsuits 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.H.R. Conf. Rep. No. 104-369, at 31 (1995), repr<strong>in</strong>ted <strong>in</strong> 1995 U.S.C.C.A.N. 679, 730. The 95 Act'splead<strong>in</strong>g requirements 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. 24 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>gFor <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.24- 41 -
acts <strong>and</strong> contrivances <strong>to</strong> deceive <strong>and</strong> 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>essthat operated as a fraud or deceit on those purchasers <strong>of</strong> Enron's securities. One man's "deeppocket" is another man'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> shieldthe 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 FACTUAL ALLEGATIONS REGARDING CIBCIn 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. The Fifth Circuit recently stated, "we will accept the facts alleged <strong>in</strong> thecompla<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., No.3-96-CV-823-R, 1996 U.S. Dist. LEXIS 21553, at *5 (N.D. Tex. Oct. 25, 1996), it is improper <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." 2525CIBC makes the po<strong>in</strong>t that the 500-page CC uses the word "help" or "helped" <strong>to</strong> describe itsconduct vis-à-vis Enron on some occasions. Seiz<strong>in</strong>g on the word help/helped, CIBC claims that itsuse 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, persons who 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 on purchasers <strong>of</strong> a- 42 -
CIBC seems <strong>to</strong> argue that the three-year statute <strong>of</strong> response for 1934 Act claims barspla<strong>in</strong>tiffs from pursu<strong>in</strong>g damages aga<strong>in</strong>st them for any time period prior <strong>to</strong> 4/8/99 <strong>and</strong> anyconsideration <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 former 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 barsdamage recovery from CIBC on behalf <strong>of</strong> purchasers who purchased before 4/8/99, it does not affectpla<strong>in</strong>tiffs' ability <strong>to</strong> plead conduct or present evidence <strong>of</strong> its misconduct prior <strong>to</strong> that date. UnitedStates 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 – "thestatute <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. 26 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."). 27public company's securities or employ acts or manipulative or deceptive devices are actually"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>rious actionsare dismissed because pleaders used an ambiguous word or mischaracterized a claim for relief.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 pleader withall ambiguities resolved <strong>and</strong> <strong>in</strong>ferences drawn <strong>in</strong> the pleader's favor. And the CC clearly doesrepeatedly allege that CIBC 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> manipulative devices <strong>and</strong>/or contrivances <strong>to</strong> deceive. That conduct is actionableunder 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.26There is no dispute that as <strong>to</strong> CIBC, claims were timely filed for the three-year period,beg<strong>in</strong>n<strong>in</strong>g 4/8/99.27An 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> his cont<strong>in</strong>u<strong>in</strong>g fraudulent scheme <strong>to</strong> defraud." Trier <strong>of</strong> fact can considerdefendant's pre-statute <strong>of</strong> limitations action <strong>to</strong> determ<strong>in</strong>e whether defendant had the requisite <strong>in</strong>tent<strong>to</strong> defraud.); United States v. Whitt, 718 F.2d 1494, 1501 (10th Cir. 1983) (Certa<strong>in</strong> testimonyregard<strong>in</strong>g events that were not with<strong>in</strong> the statute <strong>of</strong> limitations was used "<strong>to</strong> establish a scheme orplan rather than as direct evidence."); United States v. Hask<strong>in</strong>s, 737 F.2d 844, 848 (10th Cir. 1984)(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>- 43 -
A 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), petition for cert. filed, (Aug. 29, 2001), held that evidence <strong>of</strong> defendant's sexualadvances <strong>and</strong> the fact that the pla<strong>in</strong>tiff rebuffed those advances at an earlier time were relevant <strong>to</strong>show defendant's motivation for the harassment that occurred dur<strong>in</strong>g the time pla<strong>in</strong>tiff's claim wasripe. "A statute <strong>of</strong> limitations does not operate <strong>to</strong> bar the <strong>in</strong>troduction <strong>of</strong> evidence that predatesthe commencement <strong>of</strong> the limitations period but that is relevant <strong>to</strong> events dur<strong>in</strong>g the period." Id.at 365. 28 CIBC had an extensive <strong>and</strong> extremely close relationship with Enron, provid<strong>in</strong>g bothcommercial bank<strong>in</strong>g <strong>and</strong> <strong>in</strong>vestment bank<strong>in</strong>g services while help<strong>in</strong>g <strong>to</strong> structure <strong>and</strong> fund several <strong>of</strong>Enron'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. At the same time, CIBC's securitiesanalysts 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>gEnron's bus<strong>in</strong>ess success, the strength <strong>of</strong> its f<strong>in</strong>ancial condition <strong>and</strong> its prospects for strongearn<strong>in</strong>gs <strong>and</strong> revenue growth. 29 CIBC received huge underwrit<strong>in</strong>g <strong>and</strong> consult<strong>in</strong>g fees, <strong>in</strong>teresttransactions not charged <strong>in</strong> the <strong>in</strong>dictment but used <strong>to</strong> help support scheme allegations could beproperly admitted: "The fact that a number <strong>of</strong> the overt acts performed <strong>in</strong> furtherance <strong>of</strong> theconspiracy 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.28In Black Law Enforcement Officers Ass'n v. City <strong>of</strong> Akron, 824 F.2d 475 (6th Cir. 1987), theSixth Circuit found the lower court erred when it granted a motion by the city seek<strong>in</strong>g <strong>to</strong> limitevidence presented <strong>in</strong> the case <strong>to</strong> events that occurred with<strong>in</strong> the one year statute <strong>of</strong> limitationsperiod. Id. at 479. "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 theadmission <strong>of</strong> evidence. The function <strong>of</strong> the statute <strong>of</strong> limitations is <strong>to</strong> bar stale claims." Id. at 482-83. "'The statute <strong>of</strong> limitations is a defense ..., not a rule <strong>of</strong> evidence. Therefore, ... [it] has nobear<strong>in</strong>g on the admissibility <strong>of</strong> evidence.'" Id. at 483. The Sixth Circuit found that pla<strong>in</strong>tiffs werecorrect <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>show motive, <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(8th Cir. 1977)).29As 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> such dualcapacities, <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> made loans <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>g CIBC, 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.- 44 -
payments, commitment fees <strong>and</strong> other payments from Enron <strong>and</strong> related entities. Also, CIBC or <strong>to</strong>p643-644. Accord<strong>in</strong>g <strong>to</strong> Bus<strong>in</strong>ess Week:After the s<strong>to</strong>ck market crashed <strong>in</strong> 1929, Congress hauled <strong>in</strong> Wall Streetbosses <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.Bus<strong>in</strong>ess Week, 3/25/02 (643).Accord<strong>in</strong>g <strong>to</strong> the Miami Herald on 3/19/02 (644):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-Stegall Act was repealed....* * *Enron was such a lucrative cus<strong>to</strong>mer that virtually every Wall Street firm hada relationship with it.- 45 -
executives <strong>of</strong> CIBC were permitted <strong>to</strong> personally <strong>in</strong>vest (though CIBC Capital Corp.) at least $15million <strong>in</strong> Enron's lucrative LJM2 partnership as a reward <strong>to</strong> them for orchestrat<strong>in</strong>g CIBC'sparticipation <strong>in</strong> this fraud. 715, 732.CIBC 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> severalways. It participated <strong>in</strong> commercial loans <strong>and</strong> lend<strong>in</strong>g commitments <strong>of</strong> over $4.2 billion <strong>to</strong> Enrondur<strong>in</strong>g the Class Period. CIBC also helped raise over $2.3 billion from the <strong>in</strong>vest<strong>in</strong>g public forEnron via the sale <strong>of</strong> Enron <strong>and</strong> Enron-related securities dur<strong>in</strong>g the Class Period, sales accomplishedvia false Registration Statements. CIBC also helped structure <strong>and</strong> f<strong>in</strong>ance certa<strong>in</strong> <strong>of</strong> the partnershipsEnron controlled <strong>and</strong> their illicit transactions with SPEs, know<strong>in</strong>g they were vehicles be<strong>in</strong>g utilizedby Enron <strong>to</strong> falsify its reported f<strong>in</strong>ancial results. 716.CIBC acted as an underwriter <strong>of</strong> billions <strong>of</strong> dollars <strong>of</strong> Enron securities before <strong>and</strong> dur<strong>in</strong>g theClass Period, <strong>in</strong>clud<strong>in</strong>g (718):DATESECURITY11/93 8 million shares <strong>of</strong> 8% Enron capital preferred shares at $25 per share7/94 3 million shares <strong>of</strong> 9% Enron capital preferred shares at $25 per share1/97 6 million shares <strong>of</strong> 8-1/8% Enron capital preferred shares at $25 per share5/98 35 million shares Enron common s<strong>to</strong>ck at $252/99 27.6 million shares <strong>of</strong> Enron common s<strong>to</strong>ck at $31.345/99 $500 million 7.375% Enron notesCIBC was also the lead underwriter <strong>in</strong> the New Power IPO, which enabled Enron <strong>to</strong>improperly recognize <strong>and</strong> report $370 million <strong>in</strong> pr<strong>of</strong>its <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. If Enron couldtake 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 recognize a pr<strong>of</strong>i<strong>to</strong>n 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 transactionwith the LJM2 entity. 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> CIBC did the huge New Power IPO – 27.6 million shares at $21 per share<strong>in</strong> 10/00. After the IPO, Enron cont<strong>in</strong>ued <strong>to</strong> hold 13.6 million shares <strong>of</strong> New Power common s<strong>to</strong>ck<strong>and</strong> warrants <strong>to</strong> purchase 42 million more shares. In a deal secretly structured before the IPO, Enron- 46 -
created a huge phony pr<strong>of</strong>it us<strong>in</strong>g LJM2 <strong>and</strong> an SPE called Hawaii 125-0. CIBC (<strong>and</strong> several other<strong>of</strong> Enron's banks) made a "loan" <strong>of</strong> $125 million <strong>to</strong> Hawaii 125-0, but received a "<strong>to</strong>tal return swap"guarantee that was supposed <strong>to</strong> protect CIBC aga<strong>in</strong>st any loss from Enron. Enron transferredmillions <strong>of</strong> its New Power warrants <strong>to</strong> Hawaii 125-0 <strong>to</strong> "secure" the banks' loan <strong>and</strong> thus created ahuge $370 million "pr<strong>of</strong>it" on the purported ga<strong>in</strong> on the New Power warrants made possible by theNew Power IPO. Hawaii 125-0 simultaneously supposedly "hedged" the warrants with anotherentity created <strong>and</strong> controlled by Enron 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>gPorcup<strong>in</strong>e with no assets. Dur<strong>in</strong>g 01, New Power s<strong>to</strong>ck collapsed, convert<strong>in</strong>g Enron's huge ga<strong>in</strong> onits New Power equity hold<strong>in</strong>gs <strong>in</strong><strong>to</strong> a huge loss early <strong>in</strong> 01 – which Enron concealed. 42. 30Dur<strong>in</strong>g the Class Period, CIBC was also a major commercial lender <strong>to</strong> Enron. 31 For <strong>in</strong>stance(719):DATETRANSACTION11/97 $250 million credit facility for Enron7/98 $250 million loan <strong>to</strong> an Enron subsidiary guaranteed by Enron9/98 $1 billion committed credit facility for Enron <strong>to</strong> back upcommercial paper30In 7/01, CIBC also acted as an underwriter <strong>of</strong> certa<strong>in</strong> Enron-related securities, i.e., $1 billion6.31% <strong>and</strong> 6.19% Marl<strong>in</strong> Water Trust II <strong>and</strong> Marl<strong>in</strong> Water Capital Corp. II notes. 720.31In analyz<strong>in</strong>g potential borrowers on commercial loans or credit facilities, CIBC was required<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>formationfrom 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>gentliabilities, its liquidity position, any equity issuance obligations it may have which could adverselyaffect its shareholders' equity, any debt on which the borrower may be potentially liable, even if no<strong>to</strong>n 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> the borrower'sactual 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, whenCIBC made large loans <strong>to</strong> or committed itself <strong>to</strong> credit facilities for a 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>ancial condition <strong>and</strong> ongo<strong>in</strong>goperations 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, CIBCobta<strong>in</strong>ed <strong>and</strong> reta<strong>in</strong>ed extremely detailed <strong>in</strong>formation concern<strong>in</strong>g the actual f<strong>in</strong>ancial condition <strong>of</strong>Enron throughout the Class Period <strong>and</strong> was aware that the actual condition <strong>of</strong> Enron's bus<strong>in</strong>ess, itsf<strong>in</strong>ances <strong>and</strong> its f<strong>in</strong>ancial condition was far worse than was be<strong>in</strong>g publicly disclosed by Enron, or asdescribed or disclosed <strong>in</strong> each <strong>of</strong> CIBC's analyst reports on Enron. 650.- 47 -
8/01 $3 billion committed credit facility for Enron <strong>to</strong> back upcommercial paperCIBC's commercial paper back-up credit facilities for Enron were extremely significant. Theyenabled 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 paper marketwhere it could borrow billions <strong>to</strong> f<strong>in</strong>ance day-<strong>to</strong>-day operations, while CIBC pocketed hugecommitment fees on the back-up credit l<strong>in</strong>e. 719, 722-728.CIBC 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>essbecause its participation created enormous pr<strong>of</strong>its for CIBC (<strong>and</strong> its <strong>to</strong>p executives) as long as theEnron scheme cont<strong>in</strong>ued <strong>in</strong> operation – someth<strong>in</strong>g that CIBC was <strong>in</strong> a unique position <strong>to</strong> cause.While CIBC 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> this regard,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> reportstrong 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>itgrowth, 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 from public <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> the loans from CIBC <strong>to</strong> Enron so that thescheme could cont<strong>in</strong>ue. 722.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 byCIBC 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> CIBC. Thus, throughout the Class Period, CIBC waspocket<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>gfees 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 hugeamounts on an annual basis go<strong>in</strong>g forward so long as it helped perpetuate the Enron Ponzi scheme,while CIBC's <strong>to</strong>p executives pocketed huge returns on their secret <strong>in</strong>vestment <strong>in</strong> LJM2 – returnscreated by the very manipulative or deceptive acts <strong>and</strong> contrived transactions between Enron <strong>and</strong>LJM2 entities which CIBC was f<strong>in</strong>anc<strong>in</strong>g – <strong>and</strong> which were hid<strong>in</strong>g billions <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 while loot<strong>in</strong>g Enron. 722.In addition, CIBC also engaged <strong>and</strong> 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 Enron- 48 -
s<strong>to</strong>ck sale – Enron's 2/99 27.6 million share common s<strong>to</strong>ck <strong>of</strong>fer<strong>in</strong>g, Enron's 5/99 $500 million7.375% Enron notes <strong>and</strong> the New Power IPO each conta<strong>in</strong>ed false <strong>and</strong> mislead<strong>in</strong>g statements –which are statements made by CIBC as an underwriter – <strong>in</strong>clud<strong>in</strong>g false <strong>in</strong>terim <strong>and</strong> annualf<strong>in</strong>ancial statements, <strong>and</strong> false statements concern<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>ancial risk 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. 723. See <strong>in</strong>fra at 95-96.In addition, throughout the Class Period, CIBC issued 15 analysts' reports on Enron whichconta<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 1/25/99, 4/14/99, 7/14/99, 10/7/99, 10/13/99, 1/6/00,1/18/00, 1/21/00, 4/12/00, 7/24/00, 10/19/00, 4/19/01, 7/13/01, 8/15/01 <strong>and</strong> 10/17/01. 132, 148,161, 176, 183, 194, 199, 207, 230, 251, 269, 323, 334, 349, 372 <strong>and</strong> 724. See <strong>in</strong>fra at 77-94.These were all statements by CIBC <strong>to</strong> the securities markets which helped artificially <strong>in</strong>flatethe 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 price <strong>in</strong>flated wasalso important <strong>to</strong> CIBC as it knew that if the s<strong>to</strong>ck price fell below various "trigger" pricesembedded <strong>in</strong> the LJM2 SPEs CIBC was 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 itsaccess <strong>to</strong> the capital markets, <strong>and</strong> thus endanger the ongo<strong>in</strong>g scheme from which CIBC <strong>and</strong> its<strong>to</strong>p <strong>of</strong>ficials were pr<strong>of</strong>it<strong>in</strong>g. 724.In addition <strong>to</strong> its own direct liability for mak<strong>in</strong>g false <strong>and</strong> mislead<strong>in</strong>g statements, CIBC alsoengaged <strong>and</strong> participated <strong>in</strong> <strong>and</strong> furthered the fraudulent scheme by help<strong>in</strong>g <strong>to</strong> f<strong>in</strong>ance or otherwiseparticipate <strong>in</strong> illicit transactions with Enron which it knew would contribute materially <strong>to</strong> Enron'sability <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> falsify its f<strong>in</strong>ancial condition <strong>and</strong> thus cont<strong>in</strong>ue the operation <strong>of</strong> the EnronPonzi scheme.One <strong>of</strong> the primary vehicles utilized <strong>to</strong> falsify Enron's f<strong>in</strong>ancial results dur<strong>in</strong>g the ClassPeriod was LJM2, which was secretly controlled by Enron <strong>and</strong> was used <strong>to</strong> help create numerousSPEs (<strong>in</strong>clud<strong>in</strong>g the <strong>in</strong>famous Rap<strong>to</strong>rs) with which Enron 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>g billions <strong>of</strong> dollars <strong>in</strong> debt that should have been- 49 -
on Enron's balance sheet. LJM2 was a privately held entity created by Enron with the help <strong>of</strong> CIBCat year-end 99. 24, 646-647, 732.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> Merrill Lynch could not raise sufficient money from outside<strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 <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 thedesperately needed transactions with Enron. CIBC 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 like itself – basically from loot<strong>in</strong>gEnron. 646-647. So, <strong>in</strong> an extraord<strong>in</strong>ary step, CIBC, know<strong>in</strong>g that LJM2 was go<strong>in</strong>g <strong>to</strong> be anextraord<strong>in</strong>arily lucrative <strong>in</strong>vestment, put up $2.25 million early – many times more than theirallocated shares – on or about 12/22/99 – <strong>to</strong> pre-fund LJM2. This early money from Enron's banks– <strong>in</strong>clud<strong>in</strong>g CIBC – on 12/22/99, provided critical fund<strong>in</strong>g <strong>to</strong> enable Enron <strong>to</strong> engage <strong>in</strong> theWhitew<strong>in</strong>g, CLO, Nowa Sarzyna Power Plant, MEGS natural gas <strong>and</strong> Yosemite certificates dealsbetween 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> moved hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong>debt <strong>of</strong>f Enron's balance sheet. 647. These deals were then "undone" <strong>in</strong> the 1stQ 00 with hugereturns <strong>to</strong> the banks <strong>and</strong> bankers like CIBC that had pre-funded LJM2. 466-475. Dur<strong>in</strong>g 00-01,the LJM2 partnership, with the f<strong>in</strong>anc<strong>in</strong>g CIBC helped <strong>to</strong> provide, was able <strong>to</strong> form <strong>and</strong> f<strong>in</strong>anceseveral SPEs – <strong>in</strong>clud<strong>in</strong>g the Rap<strong>to</strong>rs – with which Enron engaged <strong>in</strong> manipulative or deceptivedevices <strong>and</strong> transactions <strong>to</strong> <strong>in</strong>flate its reported pr<strong>of</strong>its, while improperly mov<strong>in</strong>g billions <strong>in</strong> debt <strong>of</strong>fEnron's balance sheet <strong>and</strong> <strong>in</strong><strong>to</strong> the SPEs. 461-464, 476-488, 731-732.- 50 -
To the extent that Enron's bankers – <strong>in</strong>clud<strong>in</strong>g CIBC – were permitted <strong>to</strong> <strong>in</strong>vest <strong>in</strong> LJM2, thiswas a reward <strong>to</strong> them for their ongo<strong>in</strong>g participation <strong>in</strong> the scheme. 25, 646. 32 In this regard,as a reward for CIBC's participation <strong>in</strong> the scheme, CIBC was permitted <strong>to</strong> ultimately <strong>in</strong>vest $15million <strong>in</strong> LJM2 which facilitated the f<strong>in</strong>anc<strong>in</strong>g <strong>of</strong> that critical vehicle.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>rs that the <strong>to</strong>p flight f<strong>in</strong>ancial returns that <strong>in</strong>ves<strong>to</strong>rs made from apartnership that did bus<strong>in</strong>ess with the company could have been achieved only ifthe corporation was defrauded, accord<strong>in</strong>g <strong>to</strong> documents <strong>and</strong> people <strong>in</strong>volved <strong>in</strong> thecase.... 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> theEnron board that such returns – which were as high as 2,500 percent <strong>in</strong> onetransaction – could not have been achieved through arm's-length transactions,accord<strong>in</strong>g <strong>to</strong> these people <strong>and</strong> <strong>in</strong>vestigative notes.... 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.... In the LJM2presentation, <strong>in</strong>ves<strong>to</strong>rs were <strong>to</strong>ld that the partnership had generated rates <strong>of</strong> return onits <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.32After 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> LJM2.647. This is shown below:LJM2 PARTNERSHIP FUNDINGPartnership Inves<strong>to</strong>rBankTotal LJM-2Fund<strong>in</strong>gCommitment% <strong>of</strong> FundPre-Fund<strong>in</strong>g12/22/992d/3d CloseDraw4th CloseDrawNetInvestment@ 6/30/00Chemical Investments, Inc.; J.P.Morgan Partnership InvestmentsCorp.; Sixty Wall Street Fund, LPJP 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- 51 -
Kurt Eichenwald,"Enron Ex-Chief Said <strong>to</strong> Voice Suspicions <strong>of</strong> Fraud," New York Times, 4/24/02.Thus, these favored <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 like CIBC or the <strong>to</strong>p executives at CIBC 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 fromthe 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> 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 – from the loot<strong>in</strong>g <strong>of</strong> Enron. 649. 33CIBC <strong>and</strong> Enron also engaged <strong>in</strong> fraudulent transactions utiliz<strong>in</strong>g an entity which CIBC <strong>and</strong>Enron controlled, known as Project Braveheart, a partnership which related <strong>to</strong> Enron's VOD jo<strong>in</strong>tventure with Blockbuster <strong>and</strong> enabled Enron <strong>to</strong> improperly report over $110 million <strong>in</strong> phony pr<strong>of</strong>its<strong>in</strong> the 4thQ 00 <strong>and</strong> the 1stQ 01. 725.When Enron announced its VOD jo<strong>in</strong>t venture with Blockbuster <strong>in</strong> 7/00, <strong>and</strong> as it <strong>and</strong> CIBCdescribed that venture <strong>in</strong> follow<strong>in</strong>g months, they were extraord<strong>in</strong>arily positive about it, assur<strong>in</strong>g<strong>in</strong>ves<strong>to</strong>rs the Blockbuster VOD venture was a first-<strong>of</strong>-its-k<strong>in</strong>d, that it validated Enron's Broadb<strong>and</strong>content delivery technology <strong>and</strong> was worth more than $1 billion <strong>to</strong> Enron. They also ex<strong>to</strong>lled thehigh quality <strong>of</strong> the EIN, i.e., Enron's fiber optic system. 726.However, CIBC knew that the VOD project was very risky <strong>and</strong> was plagued by technical <strong>and</strong>legal problems that made it likely that it would never advance past a pilot project stage – at least notfor a long time. Nevertheless, CIBC worked with Enron <strong>to</strong> misuse mark-<strong>to</strong>-market account<strong>in</strong>g <strong>to</strong>improperly accelerate <strong>and</strong> record over $100 million <strong>of</strong> pr<strong>of</strong>it from the Blockbuster jo<strong>in</strong>t venture <strong>in</strong>current periods, i.e., year-end 00 <strong>and</strong> the 1stQ <strong>of</strong> 01, when Enron desperately needed <strong>to</strong> create pr<strong>of</strong>its<strong>to</strong> cover the true adverse condition <strong>of</strong> its bus<strong>in</strong>ess. Thus, on 12/28/00, CIBC <strong>and</strong> Enron formed apartnership – EBS Content Systems LLC – known as Project Braveheart. Enron <strong>and</strong> CIBC assignedan arbitrary <strong>and</strong> unrealistic value <strong>of</strong> $124 million <strong>to</strong> the partnership <strong>and</strong> CIBC agreed <strong>to</strong> <strong>in</strong>vest (notloan) $115 million <strong>in</strong> the partnership <strong>in</strong> return for a large up-front fee <strong>and</strong> the right <strong>to</strong> receive 93%33These payments from LJM2 were on <strong>to</strong>p <strong>of</strong> the huge advisory fees, underwriter fees,<strong>in</strong>terest <strong>and</strong> loan commitment fees CIBC was already gett<strong>in</strong>g from Enron. 649.- 52 -
<strong>of</strong> Enron's pr<strong>of</strong>its from the VOD jo<strong>in</strong>t venture over the next 20 years. This enabled Enron <strong>to</strong>recognize $110 million <strong>in</strong> pr<strong>of</strong>its from this transaction <strong>in</strong> the 4thQ <strong>of</strong> 00 <strong>and</strong> 1stQ <strong>of</strong> 01. 727.However, this pr<strong>of</strong>it recognition was fraudulent as the VOD jo<strong>in</strong>t venture was noth<strong>in</strong>g morethan a fail<strong>in</strong>g project. The CIBC/Enron partnership was a phony contrivance, as Enron had secretlyguaranteed CIBC's <strong>in</strong>vestment <strong>in</strong> Braveheart so that CIBC was not a true <strong>in</strong>ves<strong>to</strong>r <strong>and</strong> was notat risk. CIBC dem<strong>and</strong>ed <strong>and</strong> got its guarantee because it knew that the VOD venture was verytroubled <strong>and</strong> unlikely <strong>to</strong> succeed <strong>and</strong> entered <strong>in</strong><strong>to</strong> the transaction as an accommodation <strong>to</strong> Enron <strong>to</strong>allow Enron <strong>to</strong> create <strong>and</strong> report phony pr<strong>of</strong>its <strong>to</strong> falsify its f<strong>in</strong>ancial condition. To attempt <strong>to</strong> createthe 3% outside equity <strong>in</strong>ves<strong>to</strong>r participation necessary <strong>to</strong> create a "legitimate" SPE, Enron <strong>and</strong> CIBCgot a company called nCUBE (a contrac<strong>to</strong>r for Enron on the VOD project) <strong>to</strong> put $2 million <strong>in</strong><strong>to</strong>Braveheart at year-end 00. However, Enron <strong>and</strong> CIBC secretly promised <strong>to</strong> return that $2 millionright after year-end 00. Creat<strong>in</strong>g these phony pr<strong>of</strong>its was <strong>in</strong>dispensable <strong>to</strong> allow<strong>in</strong>g Enron <strong>to</strong> publiclystress the success <strong>of</strong> Enron's new Broadb<strong>and</strong> content delivery bus<strong>in</strong>ess. However, <strong>in</strong> reality the VODpartnership was an illusion. Enron's technology did not work – it could not deliver the content overits fiber optic network <strong>and</strong> the test <strong>of</strong> the system <strong>in</strong> late 00 was a catastrophic failure. Blockbusteralso did not have <strong>and</strong> could not obta<strong>in</strong> the legal right <strong>to</strong> provide the VOD venture content (movies)<strong>in</strong> digital form because it had not acquired <strong>and</strong> could not acquire those rights from the movie studios.The VOD venture was ab<strong>and</strong>oned <strong>in</strong> 3/01, less than eight months after it started – but Enron did notat that time reverse the over $110 million <strong>in</strong> phony pr<strong>of</strong>its it had recorded. And because CIBC knewEnron's f<strong>in</strong>ancial condition was such that it could not honor its secret guarantee <strong>to</strong> repay CIBC its$115 million <strong>in</strong>vestment <strong>in</strong> Braveheart, CIBC agreed <strong>to</strong> carry that amount for Enron until later soas <strong>to</strong> permit the Enron Ponzi scheme <strong>to</strong> cont<strong>in</strong>ue. 728.The Wall Street Journal has reported on this bogus transaction as set forth below (729): 3434To the extent CIBC argues this Braveheart transaction was not as alleged, this is a factualdenial which is not permitted at the 12b-6 stage.- 53 -
A Blockbuster DealShows How EnronOverplayed Its H<strong>and</strong>_____________Company Booked Big Pr<strong>of</strong>itFrom Pilot Video ProjectThat Soon Fizzled Out______________"I Just Couldn't Believe It"_______________When Enron Corp-. <strong>and</strong> Blockbuster Inc. jo<strong>in</strong>ed forces <strong>in</strong> mid-2000, it lookedlike they were on<strong>to</strong> someth<strong>in</strong>g big. The companies announced they would soon beallow<strong>in</strong>g consumers across America <strong>to</strong> choose from among thous<strong>and</strong>s <strong>of</strong> movies,<strong>in</strong>clud<strong>in</strong>g hot new features, sent via telephone l<strong>in</strong>es <strong>to</strong> watch on their TVs at home.Announc<strong>in</strong>g the partnership <strong>in</strong> July 2000, Enron Chairman Kenneth Laycalled it the "killer app for the enterta<strong>in</strong>ment <strong>in</strong>dustry."...It looked like another brilliant move by Enron, already a hero on Wall Street.The Hous<strong>to</strong>n company had aligned itself with the nation's lead<strong>in</strong>g video retailer. the20-year deal would br<strong>in</strong>g traffic <strong>to</strong> Enron's fledgl<strong>in</strong>g fiber-optictelecommunications network. And the venture reaffirmed the notion that Enron,already America's preem<strong>in</strong>ent energy trader, would soon be a lucrative middlemanfor a vast range <strong>of</strong> other products, as well.* * *Enron ... set up an affiliated partnership, code-named Project Braveheart ....Enron obta<strong>in</strong>ed a $115.2 million <strong>in</strong>vestment <strong>in</strong> the partnership from CIBC WorldMarkets, the <strong>in</strong>vestment-bank<strong>in</strong>g arm <strong>of</strong> Canadian International Bank <strong>of</strong> Commerce<strong>in</strong> Toron<strong>to</strong>. In return, CIBC received a promise <strong>of</strong> almost all earn<strong>in</strong>gs from Enron'sshare <strong>of</strong> the venture ....The partnership had no separate staff <strong>and</strong> no assets other than Enron's stake<strong>in</strong> the venture with Blockbuster, which was barely gett<strong>in</strong>g <strong>of</strong>f the ground <strong>in</strong> late 2000.Still, <strong>in</strong> an audacious account<strong>in</strong>g move, Enron claimed $110.9 million <strong>in</strong> pr<strong>of</strong>itsfrom Braveheart <strong>in</strong> the fourth quarter <strong>of</strong> 2000 <strong>and</strong> the first quarter <strong>of</strong> 2001. Thatamount sharply limited the overall losses suffered by Enron's young broadb<strong>and</strong>servicesdivision <strong>in</strong> the two periods.* * *"It was noth<strong>in</strong>g but a pilot project," says Blockbuster's Ms. Raskopf. "I don'tknow how anyone could have been book<strong>in</strong>g revenues." Blockbuster ... neveraccounted for any f<strong>in</strong>ancial ga<strong>in</strong> or loss from the short-lived venture, she says.Project Braveheart was one <strong>of</strong> dozens <strong>of</strong> outside partnerships that Enron<strong>of</strong>ficials created <strong>to</strong> burnish the company's f<strong>in</strong>ancial results at a time when it felt underpressure <strong>to</strong> show high pr<strong>of</strong>it that would justify its soar<strong>in</strong>g s<strong>to</strong>ck price, accord<strong>in</strong>g <strong>to</strong>current <strong>and</strong> former company executives....- 54 -
Enron's current chief f<strong>in</strong>ancial <strong>of</strong>ficer, Jeffrey McMahon, says he had noth<strong>in</strong>g<strong>to</strong> do with Braveheart or related partnerships. "I'm not go<strong>in</strong>g <strong>to</strong> defend them," hesays.* * *In exchange for its $115.2 million <strong>in</strong>vestment, CIBC was supposed <strong>to</strong> receive93% <strong>of</strong> Braveheart's cash flow for 10 years. But Enron made the <strong>in</strong>vestment <strong>in</strong> theembryonic partnership more attractive by promis<strong>in</strong>g <strong>to</strong> repay CIBC the full value<strong>of</strong> its <strong>in</strong>vestment if the partnership failed <strong>to</strong> be a money maker.Three former Enron employees familiar with the partnership deals say thatthis k<strong>in</strong>d <strong>of</strong> guarantee was designed specifically <strong>to</strong> attract <strong>in</strong>ves<strong>to</strong>rs who otherwisemight worry about the viability <strong>of</strong> the deals. "The banks didn't care about theassets they <strong>in</strong>vested <strong>in</strong> <strong>and</strong> that's how it got out <strong>of</strong> control," says one former Enronemployee who helped create some <strong>of</strong> the partnerships.* * *Enron began us<strong>in</strong>g Braveheart for account<strong>in</strong>g purposes <strong>in</strong> the fourth quarter<strong>of</strong> 2000. For that period, Enron claimed its ownership <strong>of</strong> Braveheart resulted <strong>in</strong> a$53 million pr<strong>of</strong>it, even though the Blockbuster venture was only two weeks <strong>in</strong><strong>to</strong> itspilot program <strong>and</strong> not generat<strong>in</strong>g any pr<strong>of</strong>it at all.One <strong>of</strong> the former Enron employees familiar with Braveheart recallswonder<strong>in</strong>g at the time," 'How can they monetize this asset when we're still putt<strong>in</strong>git <strong>to</strong>gether?' It didn't make any sense <strong>to</strong> me."In the follow<strong>in</strong>g quarter, the first <strong>of</strong> 2001, Enron claimed an additional $57.9million ga<strong>in</strong> from Braveheart. "I was just floored," says the former employee. "Imean, I couldn't believe it."Another example <strong>of</strong> how CIBC participated <strong>in</strong> the falsification <strong>of</strong> Enron's reported resultsis the New Power IPO, by which Enron created <strong>and</strong> improperly recognized $370 million <strong>in</strong> pr<strong>of</strong>its<strong>in</strong> the 4thQ 00. In 00, Enron controlled <strong>and</strong> owned millions <strong>of</strong> shares <strong>of</strong> New Power s<strong>to</strong>ck – thena private company. If Enron could take New Power public, create a trad<strong>in</strong>g market <strong>in</strong> its s<strong>to</strong>ck, thenEnron could recognize a pr<strong>of</strong>it on the ga<strong>in</strong> on its shares by "hedg<strong>in</strong>g" that ga<strong>in</strong> via yet another nonarm's-lengthtransaction with the CIBC f<strong>in</strong>anced-LJM2 entity. In the 4thQ 00, when Enrondesperately needed <strong>to</strong> create pr<strong>of</strong>its <strong>to</strong> perpetuate the Enron Ponzi scheme, CIBC did the huge NewPower IPO – 27.6 million shares at $21 per share. Then CIBC <strong>and</strong> Enron quickly moved <strong>to</strong> createa huge phony pr<strong>of</strong>it us<strong>in</strong>g the CIBC-f<strong>in</strong>anced LJM2. Immediately after the New Power IPO, Enron<strong>and</strong> CIBC created Hawaii 125-0. CIBC (<strong>and</strong> several other <strong>of</strong> Enron's banks) made a "loan" <strong>of</strong> $125million <strong>to</strong> Hawaii 125-0, but received a secret "<strong>to</strong>tal return swap" guarantee that protected CIBC <strong>and</strong>the other banks aga<strong>in</strong>st any loss from Enron. Enron transferred millions <strong>of</strong> its New Power warrants- 55 -
<strong>to</strong> Hawaii 125-0 <strong>to</strong> "secure" the banks' loan <strong>and</strong> created a huge $370 million "pr<strong>of</strong>it" on the purportedga<strong>in</strong> on the New Power warrants made possible by the New Power IPO. Hawaii 125-0 supposedly"hedged" the warrants with another entity created <strong>and</strong> controlled by Enron called "Porcup<strong>in</strong>e." Tosupposedly capitalize, 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> theNew Power warrants, but, one week later, Porcup<strong>in</strong>e paid the $30 million back <strong>to</strong> LJM2 plus a $9.5million pr<strong>of</strong>it – leav<strong>in</strong>g Porcup<strong>in</strong>e with no assets. Dur<strong>in</strong>g 01, New Power s<strong>to</strong>ck fell sharply. Thiscollapse <strong>in</strong> New Power's s<strong>to</strong>ck turned Enron's huge ga<strong>in</strong> on its New Power s<strong>to</strong>ck/warrants <strong>in</strong><strong>to</strong> a hugeloss early <strong>in</strong> 01 – a loss <strong>of</strong> about $250 million – which Enron concealed until 10/01. 731. 35After LJM2 was formed <strong>and</strong> CIBC had secretly been permitted <strong>to</strong> <strong>in</strong>vest <strong>in</strong> LJM2 (ultimately<strong>to</strong> the tune <strong>of</strong> over $15 million), which funded bogus deals with Enron <strong>to</strong> artificially <strong>in</strong>flate its pr<strong>of</strong>itswhile hid<strong>in</strong>g debt, <strong>and</strong> after CIBC's secret participation <strong>in</strong> the bogus Project Braveheart <strong>and</strong> Hawaii125-0 deals which created additional phony pr<strong>of</strong>its for Enron while also hid<strong>in</strong>g large amounts <strong>of</strong>debt, CIBC cont<strong>in</strong>ued <strong>to</strong> issue very positive analyst reports on Enron. Each <strong>of</strong> these reportsconta<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 CIBC secretly <strong>in</strong>vested <strong>in</strong> LJM2 or secretly f<strong>in</strong>anced the Hawaii 125-0 or Braveheart deals,which, <strong>in</strong> fact, were non-arm's-length fraudulent deals <strong>to</strong> artificially <strong>in</strong>flate Enron's earn<strong>in</strong>gs <strong>and</strong>enable <strong>to</strong>p Enron <strong>in</strong>siders <strong>and</strong> CIBC or CIBC executives <strong>to</strong> loot Enron. The failure <strong>to</strong> disclose theLJM2 <strong>in</strong>volvement <strong>of</strong> CIBC or its role <strong>in</strong> the Braveheart <strong>and</strong> Hawaii 125-0 transactions 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 conflict <strong>of</strong> <strong>in</strong>terests which Enron <strong>and</strong> CIBC knew would have cast serious doubts on theobjectivity <strong>and</strong> honesty <strong>of</strong> CIBC's analyst reports on Enron <strong>and</strong> disclosed that CIBC or its executiveshad 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.35As with the Braveheart SPE deals, CIBC's factual denials <strong>of</strong> the allegations or attempt <strong>to</strong> have<strong>in</strong>ferences drawn its way on the Hawaii 125-0 deal is improper at the 12b stage.- 56 -
IV.CIBC IS LIABLE UNDER 1933 ACT TO PURCHASERS OF ENRON'S7.375% NOTES IN 5/99 FOR SELLING THOSE SECURITIESPURSUANT TO A FALSE AND MISLEADING REGISTRATIONSTATEMENTWall Street underwriters play an extremely important – <strong>in</strong>deed <strong>in</strong>dispensable role – <strong>in</strong>protect<strong>in</strong>g <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> public companies <strong>and</strong> ensur<strong>in</strong>g that public companies <strong>and</strong> those associatedwith public companies comply with their obligations <strong>of</strong> full, fair <strong>and</strong> complete disclosure whensell<strong>in</strong>g securities <strong>to</strong> the public.By associat<strong>in</strong>g himself with a proposed <strong>of</strong>fer<strong>in</strong>g, an underwriter impliedly representsthat he has made such an <strong>in</strong>vestigation <strong>in</strong> accordance with pr<strong>of</strong>essional st<strong>and</strong>ards.Inves<strong>to</strong>rs properly rely on this added protection which has a direct bear<strong>in</strong>g on theirappraisal <strong>of</strong> the reliability <strong>of</strong> the representations <strong>in</strong> the prospectus. Theunderwriter who does not make a reasonable <strong>in</strong>vestigation is derelict <strong>in</strong> hisresponsibilities <strong>to</strong> deal fairly with the <strong>in</strong>vest<strong>in</strong>g public.In re Richmond Corp., 41 S.E.C. 398, 406 (1963). In Chris-Craft Indus. v. Piper Aircraft Corp., 480F.2d 341, 370 (2d Cir. 1973), the Second Circuit stated:Self-regulation is the ma<strong>in</strong>spr<strong>in</strong>g <strong>of</strong> the federal securities laws. No greaterreliance <strong>in</strong> our self-regula<strong>to</strong>ry system is placed on any s<strong>in</strong>gle participant <strong>in</strong> theissuance <strong>of</strong> securities than upon the underwriter. He is most heavily relied upon<strong>to</strong> verify published materials because <strong>of</strong> his expertise <strong>in</strong> apprais<strong>in</strong>g the securitiesissue <strong>and</strong> the issuer, <strong>and</strong> because <strong>of</strong> his <strong>in</strong>centive <strong>to</strong> do so. He is familiar with theprocess <strong>of</strong> <strong>in</strong>vestigat<strong>in</strong>g the bus<strong>in</strong>ess condition <strong>of</strong> a company <strong>and</strong> possesses extensiveresources for do<strong>in</strong>g so. S<strong>in</strong>ce he <strong>of</strong>ten has a f<strong>in</strong>ancial stake <strong>in</strong> the issue, he has aspecial motive thoroughly <strong>to</strong> <strong>in</strong>vestigate the issuer's strengths <strong>and</strong> weaknesses.Prospective <strong>in</strong>ves<strong>to</strong>rs look <strong>to</strong> the underwriter – a fact well known <strong>to</strong> all concerned<strong>and</strong> especially <strong>to</strong> the underwriter – <strong>to</strong> pass on the soundness <strong>of</strong> the security <strong>and</strong> thecorrectness <strong>of</strong> the registration statement <strong>and</strong> prospectus.In Escott v. Barchris Constr. Corp., 283 F. Supp. 643, 697 (S.D.N.Y. 1968), the court emphasizedthe importance <strong>of</strong> <strong>in</strong>dependent verification by underwriters:The purpose <strong>of</strong> Section 11 is <strong>to</strong> protect <strong>in</strong>ves<strong>to</strong>rs. To that end theunderwriters are made responsible for the truth <strong>of</strong> the prospectus. If they may escapethat responsibility by tak<strong>in</strong>g at face value representations made <strong>to</strong> them by thecompany's management, then the <strong>in</strong>clusion <strong>of</strong> underwriters among those liable underSection 11 affords the <strong>in</strong>ves<strong>to</strong>rs no additional protection. To effectuate the statute'spurpose, the phrase "reasonable <strong>in</strong>vestigation" must be construed <strong>to</strong> require moreeffort on the part <strong>of</strong> the underwriters than the mere accurate report<strong>in</strong>g <strong>in</strong> theprospectus <strong>of</strong> "data presented" <strong>to</strong> them by the company. It should make no differencethat this data is elicited by questions addressed <strong>to</strong> the company <strong>of</strong>ficers by theunderwriters, or that the underwriters at the time believe that the company's <strong>of</strong>ficersare truthful <strong>and</strong> reliable. In order <strong>to</strong> make the underwriters' participation <strong>in</strong> thisenterprise <strong>of</strong> any value <strong>to</strong> the <strong>in</strong>ves<strong>to</strong>rs, the underwriters must make somereasonable attempt <strong>to</strong> verify the data submitted <strong>to</strong> them. They may not rely solelyon the company's <strong>of</strong>ficers or on the company's counsel. A prudent man <strong>in</strong> themanagement <strong>of</strong> his own property would not rely on them.- 57 -
F<strong>in</strong>ally, <strong>in</strong> Feit v. Leasco Data Process<strong>in</strong>g Equip. Corp., 332 F. Supp. 544, 582 (E.D.N.Y. 1971),the court stated that underwritersare expected <strong>to</strong> exercise a high degree <strong>of</strong> care <strong>in</strong> <strong>in</strong>vestigation <strong>and</strong> <strong>in</strong>dependentverification <strong>of</strong> the company's representations. Tacit reliance on managementassertions is unacceptable; the underwriters must play devil's advocate.CIBC grossly violated these duties <strong>in</strong> its deal<strong>in</strong>gs with Enron. This Court has noted §11 is a nonfraudremedy:A pla<strong>in</strong>tiff is not required <strong>to</strong> demonstrate scienter under §11, <strong>and</strong> a defendantwill be liable for <strong>in</strong>nocent or negligent material misrepresentations. Id.Nevertheless, where §11 <strong>and</strong> §12(a)(2) claims sound <strong>in</strong> fraud, the pla<strong>in</strong>tiff is required<strong>to</strong> plead the circumstances constitut<strong>in</strong>g the alleged fraud with particularity under Rule9(b). Melder v. Morris, 27 F.3d 1097, 1100 n.6 (5th Cir. 1994); In re StacElectronics Sec. Litig., 89 F.3d 1399, 1405 & n.3 (9th Cir. 1996), cert. denied subnom. Anderson v. Clow, 520 U.S. 1103 (1997). The Fifth Circuit recently issued anop<strong>in</strong>ion that limits the hold<strong>in</strong>g <strong>of</strong> Melder <strong>and</strong> makes clear that where a compla<strong>in</strong>tdoes not allege that the defendants are liable for fraudulent or <strong>in</strong>tentional conduct,especially where it disavows <strong>and</strong> disclaims any allegations <strong>of</strong> fraud <strong>in</strong> its strictliability 1993 Securities Act claims, its claims do not "sound <strong>in</strong> fraud" <strong>and</strong> theycannot be dismissed for failure <strong>to</strong> satisfy Rule 9(b). Lone Star Ladies Inv. Club v.Schlotzsky's Inc., ___ F.3d ___, No. 99-50958, 2001 WL 21259, *2-3 (5th Cir. Jan.9, 2001).L<strong>and</strong>ry's, slip op. at 11 n.13. 36CIBC acted as an underwriter <strong>in</strong> sell<strong>in</strong>g $500 million <strong>of</strong> Enron 7.375% notes <strong>in</strong> 5/99 –pursuant <strong>to</strong> a false Registration Statement. This Registration Statement was false <strong>and</strong> mislead<strong>in</strong>gdue <strong>to</strong> the <strong>in</strong>corporation <strong>of</strong> Enron's 97-98 10-Ks <strong>and</strong> its 98 10-Qs that conta<strong>in</strong>ed Enron's admittedlyfalse 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. Therestatement <strong>of</strong> previously issued f<strong>in</strong>ancial statements is an admission that they were materially falsewhen issued – <strong>and</strong> Enron has restated these results by huge amounts. While the RegistrationStatement <strong>in</strong>cluded audited annual f<strong>in</strong>ancial statements, significantly, it also <strong>in</strong>corporated or <strong>in</strong>cludedall documents filed pursuant <strong>to</strong> §13(a) <strong>of</strong> the 1934 Act prior <strong>to</strong> the respective <strong>of</strong>fer<strong>in</strong>gs, <strong>in</strong>clud<strong>in</strong>gEnron's 98 10-Qs which conta<strong>in</strong>ed Enron's admittedly unaudited f<strong>in</strong>ancial false <strong>and</strong> mislead<strong>in</strong>g36The CC conta<strong>in</strong>s the required disclaimer. 1005.- 58 -
unaudited quarter f<strong>in</strong>ancial results. 615. 37 S<strong>in</strong>ce the <strong>in</strong>terim 98 f<strong>in</strong>ancial statements wereunaudited, they were not expertised, <strong>and</strong> CIBC is responsible for them.Thus, under 1933 Act §11, CIBC, as an underwriter <strong>in</strong> this <strong>of</strong>fer<strong>in</strong>g is prima facie liable <strong>to</strong>the purchasers <strong>of</strong> these securities subject <strong>to</strong> the defendant prov<strong>in</strong>g that <strong>in</strong> the exercise <strong>of</strong> due care ordiligence, they did not know <strong>and</strong> could not have known <strong>of</strong> the falsify <strong>of</strong> the Registration Statementsforecast<strong>in</strong>g these false f<strong>in</strong>ancial results. Given the duration <strong>and</strong> the size <strong>of</strong> the falsity <strong>of</strong> the f<strong>in</strong>ancialstatements, CIBC, which foisted these worthless securities on the public, faces quite a burden <strong>in</strong> thisregard.This exposes CIBC <strong>to</strong> §11 liability under the 1933 Act – non-fraud liability – under whichit is prima facie liable <strong>and</strong> can avoid liability only by bear<strong>in</strong>g its burden <strong>of</strong> pro<strong>of</strong> that it had, "afterreasonable <strong>in</strong>vestigation, reasonable ground <strong>to</strong> believe <strong>and</strong> did believe ... that the statements there<strong>in</strong>were true <strong>and</strong> that there was no omission <strong>to</strong> state a material fact required <strong>to</strong> be stated there<strong>in</strong> ornecessary <strong>to</strong> make the statements there<strong>in</strong> not mislead<strong>in</strong>g," i.e., the underwriter's so-called "duediligence" defense. 15 U.S.C. §77k(a)(5), (b)(3).In L<strong>and</strong>ry's, this Court upheld a §11 claim aga<strong>in</strong>st the defendant <strong>in</strong>vestment banks, stat<strong>in</strong>g:The Court also f<strong>in</strong>ds that Pla<strong>in</strong>tiffs have also adequately pled their claimsaga<strong>in</strong>st the L<strong>and</strong>ry Defendants under §11 <strong>of</strong> the Securities Act. They have identifiedspecific purportedly untrue statements <strong>in</strong> L<strong>and</strong>ry's Prospectus <strong>and</strong> alleged thatDefendants, who were direc<strong>to</strong>rs <strong>of</strong> the issuer <strong>and</strong> some <strong>of</strong> whom signed thedocument, negligently breached their duty <strong>to</strong> make a reasonable <strong>in</strong>vestigation orpossess reasonable grounds for believ<strong>in</strong>g that the representations were true <strong>and</strong> notmaterially mislead<strong>in</strong>g. The compla<strong>in</strong>t expressly disavows reliance on or<strong>in</strong>corporation <strong>of</strong> the allegations elsewhere <strong>in</strong> the compla<strong>in</strong>t alleg<strong>in</strong>g fraud, thusfall<strong>in</strong>g with<strong>in</strong> the hold<strong>in</strong>g <strong>of</strong> Melder, 27 F.3d at 1100 n.6. Lone Star Ladies Inv. Clubv. Schlotzsky's Inc., ___ F.3d ___, No. 99-50958, 2001 WL 21259, *2-3 (5th Cir. Jan.9, 2001).* * *As for the Underwriter Defendants' motion <strong>to</strong> dismiss, Section 11 imposesessentially absolute liability for false statements or omissions <strong>in</strong> a prospectus. Noscienter need be alleged Nor do the requirements <strong>of</strong> Rule 9(b) need <strong>to</strong> be met. LoneStar Ladies Inv. Club v. Schlotzsky's Inc., ___ F.3d ___, No. 99-50958, 2001 WL21259, *2-3 (5th Cir. Jan. 9, 2001). Pla<strong>in</strong>tiffs have met their plead<strong>in</strong>g burden.37While the CIBC may be able at trial <strong>to</strong> establish a defense <strong>to</strong> liability for these expertised,i.e., certified f<strong>in</strong>ancial statements, <strong>in</strong> light <strong>of</strong> the CC's allegations that CIBC knew those annualcertified f<strong>in</strong>ancial statements were false, CIBC may not do so now at the 12b-6 stage. Murphy, 1996U.S. Dist. LEXIS 22207, at *23.- 59 -
L<strong>and</strong>ry's, slip op. at 64-65. The same is true here as <strong>to</strong> CIBC. Thus, regardless <strong>of</strong> the enhancedplead<strong>in</strong>g requirements <strong>of</strong> the 95 Act or Rule 9(b) or the reach <strong>of</strong> 1934 Act §10(b)/Rule 10b-5liability, CIBC is <strong>in</strong> this case due <strong>to</strong> its 1933 Act §11 liability.V. CIBC CAN BE LIABLE UNDER 1934 ACT §10(b) AND RULE 10b-5 (i)FOR MAKING FALSE STATEMENTS, OR (ii) FOR PARTICIPATING INA FRAUDULENT SCHEME OR COURSE OF BUSINESS THATOPERATED AS A FRAUD OR DECEIT ON PURCHASERS OF ENRON'SSECURITIES, OR (iii) FOR EMPLOYING ACTS OR MANIPULATIVEDEVICES TO DECEIVEPla<strong>in</strong>tiffs here have also pleaded <strong>and</strong> are pursu<strong>in</strong>g theories <strong>of</strong> recovery aga<strong>in</strong>st CIBC that arewell-grounded <strong>in</strong> the express language <strong>of</strong> the 1934 Act. Section 10(b) <strong>of</strong> the 1934 Act states:Manipulative <strong>and</strong> deceptive devicesIt shall be unlawful for any person, directly or <strong>in</strong>directly ...* * *(b) [t]o use or employ, <strong>in</strong> connection with the purchase or sale <strong>of</strong> anysecurity ... any manipulative or deceptive device or contrivance <strong>in</strong> contravention <strong>of</strong>such rules <strong>and</strong> regulations as the Commission may prescribe as necessary orappropriate <strong>in</strong> the public <strong>in</strong>terest or for the protection <strong>of</strong> <strong>in</strong>ves<strong>to</strong>rs. 3815 U.S.C. §78j(b).provides:Rule 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 devicesIt 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)<strong>to</strong> employ any device, scheme or artifice <strong>to</strong> defraud,(b) <strong>to</strong> 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> the light <strong>of</strong> the circumstances under which they were made, notmislead<strong>in</strong>g, or(c) <strong>to</strong> 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,38Note 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 expressed <strong>in</strong> Rule 10b-5.- 60 -
<strong>in</strong> connection with the purchase or sale <strong>of</strong> any security.17 C.F.R. §240.10b-5.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"necessarily encompasses any "scheme <strong>to</strong> defraud." In Ernst & Ernst, the Court referred <strong>to</strong> thedictionary 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 formedby design; a contrivance; an <strong>in</strong>vention; project; scheme; <strong>of</strong>ten, a scheme <strong>to</strong> deceive; a stratagem; anartifice.'" 425 U.S. at 199 n.20 (quot<strong>in</strong>g Webster's International Dictionary (2d ed. 1934)). TheCourt found that a "contrivance" means "'a scheme, plan, or artifice.'" Id. (quot<strong>in</strong>g Webster'sInternational Dictionary); 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," "<strong>to</strong> make anyuntrue 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, 485 U.S. 224, the FifthCircuit had held that 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 (a) <strong>and</strong> (c) <strong>of</strong> Rule10b-5 alleg<strong>in</strong>g fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess liability. The Fifth Circuit expresslyrecognized the validity <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>tiffs 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> forced- 61 -
a large <strong>in</strong>ven<strong>to</strong>ry writedown, 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 the SEC doesnot 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 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 a scheme <strong>to</strong> defraud orcourse <strong>of</strong> bus<strong>in</strong>ess operat<strong>in</strong>g as a fraud for purposes <strong>of</strong> the first <strong>and</strong> thirdsubsections; pla<strong>in</strong>tiff's compla<strong>in</strong>t, taken as a whole, alleges that Olivetti forcedDocutel <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>esswas 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 marketplace; 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, No. SA-97-CA-1315-EP, 1998 U.S. Dist.LEXIS 23286, at *14 (W.D. Tex. Sept. 28, 1998) ("The first <strong>and</strong> third subsections, on the other h<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 Offer<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 Offer<strong>in</strong>g Circular was only a part: "Rather thanconta<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.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 is- 62 -
nonsense. 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,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, 969-70 (C.D. Cal. 1994).In Central Bank, 511 U.S. 164, a public build<strong>in</strong>g authority issued bonds <strong>to</strong> f<strong>in</strong>ance publicimprovements. Central Bank served as <strong>in</strong>denture trustee. The bonds were secured by liens cover<strong>in</strong>gproperty. The bond covenants required that the liened l<strong>and</strong> be worth at least 160% <strong>of</strong> the pr<strong>in</strong>cipalamount <strong>of</strong> the bonds. 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 perhaps the 160% value test was no longer met. The bank did noth<strong>in</strong>g. Soon afterwards,the public build<strong>in</strong>g authority defaulted on the bonds. The bonds were not publicly traded. CentralBank, which had no commercial lend<strong>in</strong>g relationship with the municipal entity <strong>in</strong>volved <strong>and</strong> whichwas not an <strong>in</strong>vestment bank, issued no analysts' 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> themunicipal bonds <strong>in</strong> issue. Clearly, this is a significantly different fact pattern from the Enronsituation.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. Id. at 180 (cit<strong>in</strong>g Basic, 485 U.S. at 243(the Supreme Court's "fraud-on-the-market" decision) for the proposition that a pla<strong>in</strong>tiff must showreliance <strong>to</strong> recover under 10b-5). "Were we <strong>to</strong> allow the aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g action proposed <strong>in</strong> this- 63 -
case, the defendant could be liable without any show<strong>in</strong>g that the pla<strong>in</strong>tiff relied upon the 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 thereliance requirement would disregard the careful limits on 10b-5 recovery m<strong>and</strong>ated by our earliercases." 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 theprices <strong>of</strong> Enron's publicly traded securities. 74, 418-424, 715-734. Thus, the reliance element isnot "absent" <strong>and</strong> the Supreme Court's prior decision <strong>in</strong> Basic is not circumvented – it is satisfied.Central Bank thus denied recovery <strong>to</strong> victims <strong>of</strong> an alleged securities fraud who pleaded onlyone theory <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.,analysts' 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 653. 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., a unanimous court upheld- 64 -
a §10(b)/Rule10b-5 compla<strong>in</strong>t alleg<strong>in</strong>g a "fraudulent scheme" <strong>in</strong>volv<strong>in</strong>g the sale <strong>of</strong> securities whereno false statement was alleged because:There certa<strong>in</strong>ly was an "act" or "practice" with<strong>in</strong> the mean<strong>in</strong>g <strong>of</strong> Rule10b-5 which operated as "a fraud or deceit" on Manhattan, the seller <strong>of</strong> theGovernment bonds.Id. at 9 (footnote omitted).This Court has stated, cit<strong>in</strong>g O'Hagan, that:liable.A defendant need not have made a false or mislead<strong>in</strong>g statement <strong>to</strong> beL<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. Buthere, <strong>of</strong> course, CIBC did allegedly make false statements <strong>in</strong> Registration Statements <strong>and</strong> analysts'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 repeatedlycited 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. 39• 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:39To 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.- 65 -
[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 also S.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, 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 & Co., 630 F.2d at 1118. 40CIBC's claim that Central Bank elim<strong>in</strong>ated scheme liability is flawed. Notwithst<strong>and</strong><strong>in</strong>gCentral 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 viable because:• It is encompassed by the express language <strong>of</strong> the statute, which prohibits the "direc<strong>to</strong>r <strong>in</strong>direct" "use or employment" <strong>of</strong> "any manipulative or deceptive device orcontrivance;"• 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;40The 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) ("No doubt Congress meant <strong>to</strong> prohibitthe full range <strong>of</strong> <strong>in</strong>genious devices that might be used <strong>to</strong> manipulate securities prices."); AffiliatedUte Citizens, 406 U.S. at 152-53 (Proscriptions <strong>of</strong> §10(b) <strong>and</strong> Rule 10b-5 "are broad <strong>and</strong>, by repeateduse <strong>of</strong> the word 'any,' are obviously meant <strong>to</strong> be <strong>in</strong>clusive. The Court has said that the 1934 Act <strong>and</strong>its companion legislative enactments embrace a 'fundamental purpose ... <strong>to</strong> substitute a philosophy<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>essethics <strong>in</strong> the securities <strong>in</strong>dustry.'") (footnote omitted) (quot<strong>in</strong>g SEC v. Capital Ga<strong>in</strong>s ResearchBureau, Inc., 375 U.S. 180, 195 (1963)); Capital Ga<strong>in</strong>s Research, 375 U.S. at 186 (1963) (§10(b)should be construed "not technically <strong>and</strong> restrictively, but flexibly <strong>to</strong> effectuate its remedialpurposes"); 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 acompla<strong>in</strong>t merely because the alleged scheme does not <strong>in</strong>volve the type <strong>of</strong> fraud that is "usuallyassociated with the sale or purchase <strong>of</strong> securities." We believe that §10 (b) <strong>and</strong> Rule 10b-5 prohibitall fraudulent schemes <strong>in</strong> connection with the purchase or sale <strong>of</strong> securities, whether the artificesemployed <strong>in</strong>volve a garden type variety <strong>of</strong> fraud, or present a unique form <strong>of</strong> deception. Novel oratypical methods should not provide immunity from the securities laws.'") (emphasis <strong>in</strong> orig<strong>in</strong>al)(quot<strong>in</strong>g A. T. Brod & Co., 375 F.2d at 397).- 66 -
• 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. 41 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.'" Central Bank,511 U.S. at 168. The Court, therefore, did not address other liability theories. Yet defendants <strong>of</strong>ferup numerous rationales 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 doesnot 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," Central Bank, 511 U.S. at 177, which must be <strong>in</strong>terpreted <strong>to</strong> mean thatliability can only be premised 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 liabilityunder Rule 10b-5(a) <strong>and</strong> (c) are supportable because scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess liability is atextually-based, primary liability theory <strong>and</strong> there is no hard <strong>and</strong> fast rule that a defendant mustmake a false statement <strong>to</strong> face §10(b) liability – while <strong>in</strong> this case CIBC did, <strong>in</strong> fact, allegedly makeseveral false <strong>and</strong> mislead<strong>in</strong>g statements.41The Central Bank decision did not dist<strong>in</strong>guish among the different subsections <strong>of</strong> Rule 10b-5.- 67 -
• 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 device[s] or contrivance[s]" language, leav<strong>in</strong>g it <strong>to</strong> the SEC <strong>to</strong> more specificallyproscribe fraudulent conduct. The SEC's rule-mak<strong>in</strong>g authority would be superfluous if the rules itadopted had <strong>to</strong> use precisely the same words as <strong>in</strong> the statute. To be sure, "the private pla<strong>in</strong>tiff maynot br<strong>in</strong>g a 10b-5 suit aga<strong>in</strong>st a defendant for acts not prohibited by the text <strong>of</strong> § 10(b)," CentralBank, 511 U.S. at 173, <strong>and</strong> "'the 1934 Act cannot be read more broadly than its language <strong>and</strong> thestatu<strong>to</strong>ry scheme reasonably permit.'" Id. at 174 (quot<strong>in</strong>g Chiarella v. United States, 445 U.S. 222,234 (1980)). But it is patently reasonable 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 "engagement" <strong>in</strong> a fraudulent "act, practice, or course <strong>of</strong> bus<strong>in</strong>ess"constitute the "use or employ[ment]" <strong>of</strong> a "manipulative or deceptive device or contrivance." 42In Ernst & Ernst, the Court implicitly found that a "scheme <strong>to</strong> defraud" falls with<strong>in</strong> themean<strong>in</strong>g <strong>of</strong> the "manipulative or deceptive device or contrivance" language <strong>of</strong> §10(b). 425 U.S. at199 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>d scienterrequirement 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 Ernst& Ernst, 425 U.S. at 199 n.20. 43The 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> securities42No 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.43The 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.- 68 -
fraud <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. 44• 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 also<strong>in</strong>dicated §10(b) liability existed where there was reliance on a defendant's "statement 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 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 or contrivance" ismuch broader than simply "a misrepresentation or omission." Therefore, if the start<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, there is no reason whyliability under §10(b) must be limited <strong>to</strong> directly mak<strong>in</strong>g misstatements or omissions or manipulat<strong>in</strong>gsecurities prices through certa<strong>in</strong> specific technical or mechanical means. 4544The 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. O'Hagan, 521U.S. at 652, 657-59. For example, the Court stated that "[t]he theory is also well-tuned <strong>to</strong> ananimat<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. See id.45As 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.- 69 -
In 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." 46If 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>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 (en banc);Competitive Assocs., 516 F.2d at 814-15 ("Not every violation <strong>of</strong> the anti-fraud provisions <strong>of</strong> thefederal securities law 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 by the securities laws."); Blackie v. Barrack, 524 F.2d 891, 903 n.19 (9th Cir. 1975)("Rule 10b-5 liability is not restricted solely <strong>to</strong> isolated misrepresentations or omissions; it may alsobe predicated on a 'practice, or course <strong>of</strong> bus<strong>in</strong>ess which operates ... as a fraud ....'"); Richardsonv. MacArthur, 451 F.2d 35, 40 (10th Cir. 1971) ("Rule 10b-5 is a remedial measure <strong>of</strong> far greaterbreadth than merely prohibit<strong>in</strong>g misrepresentations <strong>and</strong> nondisclosures concern<strong>in</strong>g s<strong>to</strong>ck prices. Noattempt is made <strong>in</strong> 10b-5 <strong>to</strong> specify what forms <strong>of</strong> deception are prohibited; rather, all fraudulentschemes <strong>in</strong> connection with the purchase <strong>and</strong> sale <strong>of</strong> securities are prohibited.") (emphasis added<strong>and</strong> <strong>in</strong> orig<strong>in</strong>al).• 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,46Even 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.- 70 -
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" as opposed <strong>to</strong> that whichconstitutes a "secondary" violation <strong>of</strong> the statute. Nor did it hold that only "primary" violations arecognizable. 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>terpretedby the courts, aiders <strong>and</strong> abet<strong>to</strong>rs did not commit violations but only assisted them, <strong>and</strong> the statuteholds 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 are primary liabilitytheories <strong>in</strong> the sense that the defendant is directly liable for committ<strong>in</strong>g a violation <strong>of</strong> the statute.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> Rule10b-5. With respect <strong>to</strong> fraudulent acts, practices <strong>and</strong> a participation <strong>in</strong> the scheme <strong>to</strong> defraud orfraudulent course <strong>of</strong> bus<strong>in</strong>ess is itself the manipulative or deceptive act, even without the mak<strong>in</strong>g <strong>of</strong>misrepresentations or omission. There is noth<strong>in</strong>g derivative, vicarious or secondary about it. AndCIBC 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., 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 defendant argued thatthe §10(b) claim should be dismissed for failure <strong>of</strong> the pla<strong>in</strong>tiffs <strong>to</strong> allege any misrepresentations oromissions <strong>of</strong> material facts. Id. at *10-*11. The court rejected that argument, specifically f<strong>in</strong>d<strong>in</strong>gthat 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 Hanover Energy, 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> posta letter <strong>of</strong> credit, could fairly be viewed as manipulative or deceptive with<strong>in</strong> the mean<strong>in</strong>g <strong>of</strong> §10(b)- 71 -
<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. Seeid. 4747District 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 S<strong>of</strong>tware, when discuss<strong>in</strong>g the plead<strong>in</strong>g requirements <strong>in</strong> securitiesfraud 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 amended compla<strong>in</strong>tfails <strong>to</strong> allege with any particularity that n<strong>in</strong>e <strong>of</strong> the eleven <strong>in</strong>dividual Defendantsmade any representations or participated <strong>in</strong> any way <strong>in</strong> the alleged scheme <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> thealleged scheme <strong>and</strong> specifically pled what he learned, when he learned it, <strong>and</strong> howPla<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, 904-05.District court decisions before Central Bank also recognized scheme liability. In ZZZZ Best,the district court directly addressed Ernst & Young's liability under subsections (a) <strong>and</strong> (c) <strong>of</strong> Rule10b-5, explicitly recogniz<strong>in</strong>g that liability under §10(b) <strong>and</strong> Rule 10b-5 is not restricted <strong>to</strong> materialmisstatements <strong>and</strong> omissions. 864 F. Supp. at 971-72 ("It appears that the scope <strong>of</strong> deceptive devicesor schemes prohibited by subsections (a) <strong>and</strong> (c) [<strong>of</strong> Rule 10b-5] is quite extensive."). The pla<strong>in</strong>tiffsalleged that Ernst & Young, hired <strong>to</strong> review the company's f<strong>in</strong>ancial statements, was primarily liablebecause it participated <strong>in</strong> the creation <strong>of</strong> publicly released statements, issued a review report, <strong>and</strong>failed <strong>to</strong> disclose additional material facts related <strong>to</strong> the review report. Ernst & Young moved fordismissal on the grounds that it was really be<strong>in</strong>g charged with aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g liability precludedby Central Bank. The court denied the motion, conclud<strong>in</strong>g that the facts taken as a whole as <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, the pla<strong>in</strong>tiffs alleged that Deloitte & Touche was primarily liable under §10(b) formisrepresentations <strong>and</strong> "participation <strong>in</strong> a scheme <strong>to</strong> defraud" through its <strong>in</strong>volvement with theissuer's press releases <strong>and</strong> f<strong>in</strong>ancial statements. 884 F. Supp. at 1401. The pla<strong>in</strong>tiffs also alleged thatDeloitte 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 withgenerally accepted audit<strong>in</strong>g st<strong>and</strong>ards. Id. at 1399. The court denied the account<strong>in</strong>g firm's motion<strong>to</strong> dismiss because it found that its participation <strong>in</strong> the preparation <strong>of</strong> the issuer's statements 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 sohold<strong>in</strong>g, the court recognized that Rule 10b-5(b) "essentially outlaws the mak<strong>in</strong>g <strong>of</strong> a materialmisrepresentation or omission," but that subsections (a) <strong>and</strong> (c) <strong>of</strong> the Rule "also" outlaw fraudulentschemes <strong>and</strong> courses <strong>of</strong> conduct. Id. at 1400.In In re Union Carbide Corp. Consumer Prods. Bus. 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 made otherpublic 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>esswhich operates or would operate as a fraud or deceit upon any person' <strong>in</strong> violation <strong>of</strong> 10b-5(3)."- 72 -
A scheme is "'[a] plan or program <strong>of</strong> someth<strong>in</strong>g <strong>to</strong> be done.'" 48 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. 49 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"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 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, the Court observed that "the second subparagraph <strong>of</strong> the rulespecifies 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 materialfact," 406 U.S. 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' fraud48Aaron, 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 ....[H]ence, [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."49In Harris v. United States, 48 F.2d 771 (9th Cir. 1931), for example, "[t]he fraudulent schemecharged ... 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 the manipulation <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 reports concern<strong>in</strong>g them<strong>in</strong>e through the mails." Id. at 774. "In fact, the whole scheme centered around the establishment<strong>of</strong> an alleged s<strong>to</strong>ck exchange value which is <strong>in</strong> fact wholly fictitious." Id. at 775.- 73 -
on 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(a) <strong>and</strong> (c). 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 Offer<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 Offer<strong>in</strong>g Circular was only a part: "Rather than conta<strong>in</strong><strong>in</strong>g the entirefraud, 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, 137 F.3d 616, pla<strong>in</strong>tiffs sued Merisel, its <strong>of</strong>ficers <strong>and</strong> direc<strong>to</strong>rs, its accountants,Deloitte & Touche <strong>and</strong> Lehman Brothers <strong>and</strong> Rob<strong>in</strong>son-Humphrey, <strong>in</strong>vestment banks whichserved as underwriters <strong>of</strong> Merisel's public <strong>of</strong>fer<strong>in</strong>gs <strong>and</strong> issued analysts' reports on Merisel. Thecompla<strong>in</strong>t alleged that "'defendants falsely presented the Company's current <strong>and</strong> future bus<strong>in</strong>essprospects <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 theCompany's revenue <strong>and</strong> earn<strong>in</strong>gs growth was strong <strong>and</strong> would cont<strong>in</strong>ue.'" Id. at 620.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 ...."- 74 -
In First Jersey, 101 F.3d 1450, a <strong>to</strong>p First Jersey corporate <strong>of</strong>ficial who had not made anyfalse statement claimed he should not be held liable under §10(b) <strong>of</strong> the 1934 Act for an extensiveviolation <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 securitieslaws....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.Id. at 1471-72.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 628, 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 analysts' 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 [the- 75 -
company]; 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 analystswere aware <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 analysts' 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>taga<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)." Id.at *25. In <strong>in</strong>itially deny<strong>in</strong>g the bank's motion <strong>to</strong> dismiss, the court recognized that "any person orentity 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 court concluded: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 "constant- 76 -
access" <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.Murphy, 1996 U.S. Dist. LEXIS 22207, at *21-*23 (footnote omitted).In later deny<strong>in</strong>g summary judgment, the court noted that the defendants' motive <strong>in</strong>cluded a"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.* * *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 pla<strong>in</strong>tiffs' §11 claims sufficientunder a 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 scienter adequately alleged. The key <strong>to</strong> pla<strong>in</strong>tiff's scienterallegations aga<strong>in</strong>st CIBC was that CIBC allegedly made a $4.6 million payment <strong>to</strong> Livent <strong>in</strong> return- 77 -
for play royalties, which <strong>in</strong> reality was a secret "bridge" loan, as CIBC had a side agreement fromLivent <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 Livent recorded<strong>in</strong>come on the transaction, but did not record the loan. The district court held: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 alleged fraudulentarrangement were reported by Livent as current revenue <strong>in</strong> its accounts <strong>and</strong> publicregistration statements <strong>in</strong> order [<strong>to</strong>][sic] 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.* * *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.- 78 -
Id. at 151-54.* * *The Noteholders' plead<strong>in</strong>gs ... allege misconduct that <strong>in</strong>volved CIBC <strong>in</strong> more thanmerely aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g Livent's fraudulent transactions. Rather, read <strong>in</strong> their<strong>to</strong>tality, <strong>and</strong> draw<strong>in</strong>g all reasonable <strong>in</strong> the Noteholders' favor, the Noteholders' claimsassert that CIBC played what amounts <strong>to</strong> a primary rather than a secondary role <strong>in</strong> thealleged misrepresentations. The Noteholders effectively state that CIBC was<strong>in</strong>volved as an <strong>in</strong>sider which not only aided <strong>in</strong> structur<strong>in</strong>g the fraudulent arrangementembodied <strong>in</strong> the CIBC Wood Gundy Agreement but actually solicited <strong>and</strong> itself sold<strong>to</strong> public <strong>in</strong>ves<strong>to</strong>rs Notes whose f<strong>in</strong>ancial worth depended <strong>in</strong> part on the truthconcern<strong>in</strong>g that transaction. The Noteholders contend that CIBC's false ormislead<strong>in</strong>g statements <strong>to</strong> <strong>in</strong>ves<strong>to</strong>rs were reflected not just <strong>in</strong> its omitt<strong>in</strong>g <strong>to</strong> disclosematerial facts <strong>in</strong> connection with its sales <strong>of</strong> Notes, but <strong>in</strong> more affirmative, ifimplicit misrepresentations.Similarly, <strong>in</strong> Cascade, 840 F. Supp. 1558, the court found that allegations that a securitiesbroker ignored red flags presented a sufficient show<strong>in</strong>g <strong>of</strong> recklessness <strong>to</strong> constitute scienter.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> recommend Cascade'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, Ltd. In Bre-X M<strong>in</strong>erals, pla<strong>in</strong>tiffsalleged <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>esstransactions, 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 – ignor<strong>in</strong>g "red- 79 -
flags" that Bre-X's claimed assets were falsified. Thus, J.P. Morgan's motion <strong>to</strong> dismiss wasdenied. 50 The CC <strong>in</strong> this action pleads more wrongful conduct by CIBC vis-à-vis the fraudulent 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 above cases wherecompla<strong>in</strong>ts nam<strong>in</strong>g banks as defendants <strong>in</strong> §10(b)/Rule 10b-5 actions were upheld.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. Obviously, the allegations aga<strong>in</strong>st CIBC <strong>in</strong> this case are much more detailedthan those found want<strong>in</strong>g <strong>in</strong> L<strong>and</strong>ry's. The specifics regard<strong>in</strong>g (i) CIBC's (or its executives) prefund<strong>in</strong>g<strong>of</strong> the LJM2 partnership <strong>in</strong> 2/99, (ii) fund<strong>in</strong>g <strong>of</strong> LJM2 <strong>to</strong> enable it <strong>to</strong> engage <strong>in</strong> the year-end99 non-arm's-length fraudulent transactions, (iii) their ongo<strong>in</strong>g fund<strong>in</strong>g <strong>of</strong> LJM2 <strong>in</strong> 00-01 <strong>to</strong> enableit <strong>to</strong> engage <strong>in</strong> several more such transactions <strong>in</strong> 00-01 <strong>to</strong> artificially boost Enron's reported pr<strong>of</strong>itsby hundreds <strong>of</strong> millions <strong>of</strong> dollars, while hid<strong>in</strong>g billions <strong>of</strong> dollars <strong>of</strong> debt while CIBC or its <strong>to</strong>pexecutives as LJM2 <strong>in</strong>ves<strong>to</strong>rs pocketed the fruits <strong>of</strong> those fraudulent deals – the loot<strong>in</strong>g <strong>of</strong> Enron –its participation <strong>in</strong> <strong>and</strong> fund<strong>in</strong>g <strong>of</strong> the bogus Braveheart <strong>and</strong> Hawaii 125-0 transactions whichenabled Enron <strong>to</strong> report hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> phony pr<strong>of</strong>its, (iv) CIBC's <strong>in</strong>volvement50See also U.S. Envtl., 155 F.3d at 112 (while there is no aid<strong>in</strong>g <strong>and</strong> abett<strong>in</strong>g, where compla<strong>in</strong>tproperly alleged defendant <strong>to</strong> be primary viola<strong>to</strong>r because he "'participated <strong>in</strong> the fraudulentscheme,'" not<strong>in</strong>g "lawyers, accountants, <strong>and</strong> banks who engage <strong>in</strong> fraudulent or deceptivepractices at their client's direction [are] a primary viola<strong>to</strong>r"); Scholnick, 752 F. Supp. at 1323 & n.9("bank ... may still be held liable under Rule 10b-5(a) <strong>and</strong> 10b-5(c) as a participant <strong>in</strong> the allegedlyfraudulent 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 afraudulent scheme dist<strong>in</strong>guish" case from situation where bank was only engag<strong>in</strong>g <strong>in</strong> a "'rout<strong>in</strong>ecommercial f<strong>in</strong>anc<strong>in</strong>g transaction'").- 80 -
<strong>in</strong> the New Power IPO <strong>and</strong> the secret Hawaii 125-0 side deal <strong>to</strong> create a phony $370 million pr<strong>of</strong>itfor Enron, (v) its <strong>in</strong>volvement <strong>in</strong> the bogus Braveheart SPE deal which created a phony $110 millionpr<strong>of</strong>it for Enron, <strong>and</strong> (vi) its extensive <strong>in</strong>vestment bank<strong>in</strong>g <strong>and</strong> commercial lend<strong>in</strong>g relationshipswith Enron, as well as its extensive <strong>and</strong> cont<strong>in</strong>u<strong>in</strong>g <strong>in</strong>vestment bank<strong>in</strong>g <strong>and</strong> commercial bank<strong>in</strong>grelationship with Enron, dist<strong>in</strong>guish the plead<strong>in</strong>g here from the one found want<strong>in</strong>g <strong>in</strong> L<strong>and</strong>ry's.Here, CIBC <strong>to</strong>ok affirmative steps <strong>to</strong> further the fraud. It participated <strong>in</strong> – funded <strong>and</strong> facilitated –non-arm's-length fraudulent deals with Enron that enabled CIBC <strong>to</strong> pr<strong>of</strong>it from loot<strong>in</strong>g Enron <strong>and</strong>enabled Enron <strong>to</strong> falsify its pr<strong>of</strong>its <strong>and</strong> hide debt. Noth<strong>in</strong>g remotely approach<strong>in</strong>g this was alleged<strong>in</strong> L<strong>and</strong>ry's.VI.CIBC MADE FALSE AND MISLEADING STATEMENTS INREGISTRATION STATEMENTS AND ANALYSTS REPORTSCIBC admits that its analysts issued at least 13 analysts' reports on Enron dur<strong>in</strong>g the ClassPeriod. Mot. at 6, 22. None <strong>of</strong> the cases cited by CIBC hold that <strong>in</strong>vestment banks cannot (or evenshould not) be liable for statements <strong>of</strong> their analysts. Indeed, CIBC would have <strong>to</strong> disavow it issuedanalyst reports (among other th<strong>in</strong>gs) <strong>to</strong> give any mean<strong>in</strong>g <strong>to</strong> the cases CIBC cites at pages 20-21<strong>of</strong>its <strong>Motion</strong>. CIBC does not do that. Nor do any <strong>of</strong> the cases CIBC cites support the <strong>in</strong>crediblesuggestion that CIBC cannot be liable for conceal<strong>in</strong>g its $115.2 million <strong>in</strong>vestment <strong>in</strong> ProjectBraveheart, Enron's subsequent account<strong>in</strong>g <strong>of</strong> that transaction, or CIBC's knowledge that the VODventure was troubled.CIBC asserts that the CC does not identify with specificity any false statement by it. To thecontrary, the CC specifies that CIBC made false <strong>and</strong> mislead<strong>in</strong>g statements <strong>in</strong> the RegistrationStatements for the sale <strong>of</strong> $500 million <strong>of</strong> 7.375% Enron notes <strong>in</strong> 5/99 issued dur<strong>in</strong>g the ClassPeriod, which exposes it <strong>to</strong> 1933 Act §11 liability. See <strong>in</strong>fra at 95-96.The CC also specifies CIBC made numerous false <strong>and</strong> mislead<strong>in</strong>g statements <strong>in</strong> the analystreports it issued on Enron between 10/14/98 <strong>and</strong> 10/17/01. These are detailed below. Enron's s<strong>to</strong>ckwas a weak performer, basically track<strong>in</strong>g the s<strong>to</strong>ck <strong>of</strong> companies <strong>in</strong> its "peer <strong>in</strong>dex." In order <strong>to</strong> pushEnron's s<strong>to</strong>ck higher, CIBC issued positive reports on Enron.On 10/14/98, CIBC issued a report on Enron. The report stated:- 81 -
Enron reported third quarter net <strong>in</strong>come <strong>of</strong> $[0.235] per share ... better than ourestimate <strong>of</strong> $[0.22]. [G]rowth has been spearheaded by sharp ga<strong>in</strong>s <strong>in</strong> WholesaleEnergy Operations <strong>and</strong> Services ....* * *Enron Energy Services provides comprehensive energy solutions <strong>to</strong> U.S. commercial<strong>and</strong> light <strong>in</strong>dustrial end-users. Future retail contracts grow<strong>in</strong>g; futureundiscounted revenues should exceed $3 billion by year-end. Managementcont<strong>in</strong>ues <strong>to</strong> build its retail bus<strong>in</strong>ess under Enron Energy Services.... The divisionis expected <strong>to</strong> turn pr<strong>of</strong>itable dur<strong>in</strong>g the second half <strong>of</strong> 1999. Dur<strong>in</strong>g the thirdquarter the company signed contracts represent<strong>in</strong>g $850 million <strong>of</strong> <strong>to</strong>tal futureenergy expenditures, tak<strong>in</strong>g the <strong>to</strong>tal under contract <strong>to</strong> $2.3 billion. EES's backlog<strong>of</strong> retail contracts the division is now pursu<strong>in</strong>g approximates $12 billion withaverage contract life <strong>of</strong> 5 years. Contracts under negotiation ... outsourc<strong>in</strong>g<strong>in</strong>come which should carry higher marg<strong>in</strong>s.120.On 1/25/99, CIBC issued a report on Enron, stat<strong>in</strong>g:[W]e believe longer term earn<strong>in</strong>gs power should build at attractive rates ....Follow<strong>in</strong>g operat<strong>in</strong>g setbacks 1995-1997, Enron has re-emerged as a sec<strong>to</strong>rfavorite....At last week's analyst conference ... management provided significant details on itslong-range plans <strong>to</strong> build market share <strong>and</strong> earn<strong>in</strong>gs power along several highergrowth fronts.* * *... Future retail contracts are grow<strong>in</strong>g; future undiscounted revenues shouldexceed $3 billion by year-end.... The division is expected <strong>to</strong> turn pr<strong>of</strong>itable dur<strong>in</strong>gthe second half <strong>of</strong> 1999. Dur<strong>in</strong>g the fourth quarter, the company signed contractsrepresent<strong>in</strong>g $1.8 billion <strong>of</strong> <strong>to</strong>tal future energy expenditures, tak<strong>in</strong>g the <strong>to</strong>tal undercontract <strong>to</strong> $3.8 billion....132.On 4/14/99, CIBC issued a report on Enron, rat<strong>in</strong>g forecast<strong>in</strong>g 00 <strong>and</strong> 01 EPS <strong>of</strong> $1.325 <strong>and</strong>$1.475 for Enron, <strong>and</strong> stat<strong>in</strong>g:Enron reported 1999 Q-1 <strong>in</strong>come <strong>of</strong> $253 MM or $[0.34] per share ... above our ...estimate .... Improved performance was driven by cont<strong>in</strong>ued momentum at EnronWholesale Services.... Accord<strong>in</strong>gly, we believe longer term earn<strong>in</strong>g power shouldbuild at attractive rates ....* * *In recent months the relative strength <strong>in</strong> ENE shares can be attributed <strong>to</strong> three fac<strong>to</strong>rs.1) cont<strong>in</strong>ued momentum at Enron Wholesale Services 2) ris<strong>in</strong>g expectations <strong>and</strong>valuations for Enron Energy Services (EES), Enron's retail market<strong>in</strong>g arm, follow<strong>in</strong>gmanagement's <strong>in</strong>creased expectations for the potential size <strong>of</strong> the higher marg<strong>in</strong>energy management/outsourc<strong>in</strong>g bus<strong>in</strong>ess, <strong>and</strong> 3) clarification <strong>of</strong> the company's- 82 -
strategy <strong>and</strong> potential <strong>in</strong> communication <strong>and</strong> water bus<strong>in</strong>esses. As managementcont<strong>in</strong>ues <strong>to</strong> build on core strengths <strong>in</strong> these areas we would expect the share pricepremium <strong>to</strong> hold.148.By 4/99, Enron's s<strong>to</strong>ck had moved higher <strong>and</strong> was outperform<strong>in</strong>g its peer <strong>in</strong>dex, <strong>in</strong> part due<strong>to</strong> the positive statements <strong>in</strong> CIBC's analysts' reports. The statements made <strong>in</strong> the three analysts'reports issued by CIBC between 10/14/98-4/14/99, were false or mislead<strong>in</strong>g when issued. The truebut 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."(e)The value <strong>of</strong> contracts entered <strong>in</strong><strong>to</strong> by EES was grossly overstated by themisuse <strong>and</strong> abuse <strong>of</strong> mark-<strong>to</strong>-market account<strong>in</strong>g <strong>to</strong> create huge current-period values on what were,<strong>in</strong> fact, highly speculative long-term contracts on which Enron was almost certa<strong>in</strong> <strong>to</strong> lose money.- 83 -
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>ancial results, but allowed <strong>to</strong>p EES managers <strong>and</strong> executives <strong>to</strong>collect huge bonuses based on these improperly <strong>in</strong>flated contract valuations.(f)It was impossible for EES <strong>to</strong> enter <strong>in</strong><strong>to</strong> energy contracts that extended beyondthree years <strong>and</strong> accurately account for energy costs or sav<strong>in</strong>gs because <strong>of</strong> the variables related <strong>to</strong>these contracts. Enron misused these variables <strong>in</strong> long-term contracts <strong>to</strong> manipulate its assumptions– mov<strong>in</strong>g the earn<strong>in</strong>gs curve <strong>to</strong> create larger contract values <strong>and</strong> record higher revenues abus<strong>in</strong>gmark-<strong>to</strong>-market account<strong>in</strong>g.(g)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 WEOS <strong>and</strong> EES operations were completely false, <strong>in</strong> part, because thehis<strong>to</strong>rical f<strong>in</strong>ancial performance <strong>and</strong> condition <strong>of</strong> those operations had been materially falsified –thus there was no real basis upon which <strong>to</strong> forecast such further growth – <strong>and</strong> because neither <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 for futuregrowth that were be<strong>in</strong>g made.(h)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, 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. 155.On 7/14/99, CIBC issued a report on Enron, stat<strong>in</strong>g:Enron reported 1999 Q-2 <strong>in</strong>come <strong>of</strong> $222 MM or $[0.27] per share ... above our$[0.24] estimate .... [W]e believe longer term earn<strong>in</strong>g power should build atattractive rates ....We are rais<strong>in</strong>g our 1999 <strong>and</strong> 2000 EPS estimates <strong>to</strong> $[1.175] <strong>and</strong> $[1.35] <strong>to</strong> reflectthe stronger quarter <strong>and</strong> improved prospects across wholesale energy <strong>and</strong> retailmarkets.* * *... [E]arn<strong>in</strong>gs power should cont<strong>in</strong>ue <strong>to</strong> build over the next five years.- 84 -
161.Dur<strong>in</strong>g the second half <strong>of</strong> 99, Enron's s<strong>to</strong>ck languished. CIBC cont<strong>in</strong>ued <strong>to</strong> issue analysts'reports <strong>to</strong> try <strong>to</strong> push Enron's s<strong>to</strong>ck. On 10/7/99, CIBC issued a report on Enron which upgradedEnron s<strong>to</strong>ck <strong>to</strong> "Buy" <strong>and</strong> forecast 00 <strong>and</strong> 01 EPS <strong>of</strong> $1.35 <strong>and</strong> $1.53 for Enron <strong>and</strong> stated:176.With the s<strong>to</strong>ck correct<strong>in</strong>g 14% ...we are upgrad<strong>in</strong>g Enron ... <strong>to</strong> BUY ....* * *... As management cont<strong>in</strong>ues <strong>to</strong> build on core strengths <strong>in</strong> these areas, we expectthe share price premium <strong>to</strong> hold.Enron Energy Services* * *Enron Energy Services provides comprehensive solutions <strong>to</strong> U.S. commercial <strong>and</strong>light <strong>in</strong>dustrial end-users. Retail contracts are grow<strong>in</strong>g, <strong>and</strong> future undiscountedrevenue should approximate $12 billion by year-end. Management cont<strong>in</strong>ues <strong>to</strong> buildits retail bus<strong>in</strong>ess under EES; notable cus<strong>to</strong>mers <strong>in</strong>clude Lockheed Mart<strong>in</strong>, Lucent,Applied Materials, TRW, PacTel, General Cable <strong>and</strong> a number <strong>of</strong> educational<strong>in</strong>stitutions.On 10/13/99, CIBC issued a report on Enron. It rated Enron a "Buy" <strong>and</strong> forecast 00 <strong>and</strong> 01EPS <strong>of</strong> $1.35 <strong>and</strong> $1.53 for Enron. It also stated:183.[M]anagement aggressively targets higher growth bus<strong>in</strong>esses.... [T]o concentrate onthe wholesale <strong>and</strong> retail delivery <strong>of</strong> energy <strong>and</strong> communications products <strong>and</strong>services.* * *Retail Energy Services.... Dur<strong>in</strong>g Q3-99 EES entered <strong>in</strong><strong>to</strong> contracts represent<strong>in</strong>g $2.5billion <strong>of</strong> cus<strong>to</strong>mers' future expenditures for energy services, or three times the $850million contracted <strong>in</strong> Q3-98. The Q3-99 results <strong>in</strong>clude the largest contract signed<strong>to</strong> date – a more than $1 billion ten-year outsourc<strong>in</strong>g agreement with Owens Corn<strong>in</strong>g.... Importantly, EES is expected <strong>to</strong> meet or exceed its target <strong>of</strong> sign<strong>in</strong>g $8 billion <strong>of</strong>contracts <strong>in</strong> 1999, represent<strong>in</strong>g more than double the value <strong>of</strong> contracts signed dur<strong>in</strong>g1998. EES bus<strong>in</strong>ess plan is firmly on track <strong>to</strong> make a positive contribution <strong>to</strong>Enron's earn<strong>in</strong>gs dur<strong>in</strong>g the fourth quarter <strong>of</strong> 1999.On 1/6/00, CIBC issued a report on Enron. It rated Enron a "Buy" <strong>and</strong> forecast 00 <strong>and</strong> 01EPS <strong>of</strong> $1.35 <strong>and</strong> $1.53 for Enron. It also stated:• Enron ... is now aggressively mov<strong>in</strong>g ahead with major <strong>in</strong>itiatives <strong>in</strong>communications. Year 2000 is expected <strong>to</strong> mark a major push <strong>in</strong><strong>to</strong> broadb<strong>and</strong>- 85 -
communications services, an enterprise <strong>of</strong>fer<strong>in</strong>g significant value creationpotential.... Accord<strong>in</strong>gly, we expect ENE shares <strong>to</strong> susta<strong>in</strong> solid momentum ....194.On 1/18/00, CIBC issued a report on Enron. It rated Enron a "Buy" <strong>and</strong> forecast 00 <strong>and</strong> 01EPS <strong>of</strong> $1.35 <strong>and</strong> $1.53 for Enron. It also stated:199.Enron reported Q499 EPS <strong>of</strong> $0.31 ... up from $0.24 a year ago .... Full year earn<strong>in</strong>gsreached $1.18, up from $1.10 a year ago. Earn<strong>in</strong>gs advanced 29% for the quarter <strong>and</strong>18% for the full year. We cont<strong>in</strong>ue <strong>to</strong> rate ENE shares a BUY....Improved results were driven by ga<strong>in</strong>s at all segments.... Enron Energy Services, thecompany's retail services bus<strong>in</strong>ess, turned pr<strong>of</strong>itable as expected.On 1/21/00, CIBC issued a report on Enron by Hyler. It rated Enron a "Buy," forecast 00 <strong>and</strong>01 EPS <strong>of</strong> $1.35 <strong>and</strong> $1.53 for Enron <strong>and</strong> stated:207.We are rais<strong>in</strong>g our 2000 price target <strong>to</strong> $80 ... <strong>in</strong> response <strong>to</strong> 1) furtherclarification <strong>of</strong> Enron's broadb<strong>and</strong> communications strategy ... <strong>and</strong> 2) cont<strong>in</strong>uedstrong growth rates at its wholesale <strong>and</strong> retail energy bus<strong>in</strong>esses ... withmomentum expected <strong>to</strong> cont<strong>in</strong>ue <strong>to</strong> build through 2000 ....By 1/00, Enron's s<strong>to</strong>ck had soared much higher, <strong>to</strong> over $70 per share due, <strong>in</strong> part, <strong>to</strong> thepositive analysts' reports on Enron issued by CIBC. However, the statements made <strong>in</strong> the sixanalysts' reports issued by CIBC between 7/14/99-1/21/00, 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>.- 86 -
(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." "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.- 87 -
(g)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 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.(h)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 due <strong>to</strong> current problems <strong>in</strong> thatbus<strong>in</strong>ess, as well as the current state <strong>of</strong> EBS bus<strong>in</strong>ess, such revenue <strong>and</strong> pr<strong>of</strong>it forecasts <strong>and</strong>valuations were unobta<strong>in</strong>able.(i)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.(j)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.Between 4/00 <strong>and</strong> 7/00, CIBC cont<strong>in</strong>ued <strong>to</strong> issue very strong positive reports on Enron thathelped Enron's s<strong>to</strong>ck climb <strong>to</strong> its all-time high <strong>of</strong> $90-3/4 <strong>in</strong> 8/00. On 4/12/00, CIBC issued a repor<strong>to</strong>n Enron. It rated Enron a "Buy," forecast 00 <strong>and</strong> 01 EPS <strong>of</strong> $1.38 <strong>and</strong> $1.58 for Enron, <strong>and</strong> stated:- 88 -
Enron announced an 18% <strong>in</strong>crease <strong>in</strong> per share earn<strong>in</strong>gs <strong>to</strong> $0.40 per share, up from$0.34 per share a year ago <strong>and</strong> above the $0.37 consensus. Net <strong>in</strong>come <strong>in</strong>creased34% <strong>to</strong> $338 million.* * *Enron Retail Services, a key company growth area, reported EBIT <strong>of</strong> $16 million ona sharp <strong>in</strong>crease <strong>in</strong> revenues <strong>to</strong> $642 million, up from $370 million a year ago. $3.7billion <strong>of</strong> new contracts were recorded, ahead <strong>of</strong> our expectations <strong>of</strong> $3 billion.230.On 7/24/00, CIBC issued a report on Enron. The report rated Enron a "Buy," <strong>in</strong>creasedEnron's forecasted 00 <strong>and</strong> 01 EPS <strong>to</strong> $1.42 <strong>and</strong> $1.62 <strong>and</strong> stated:We cont<strong>in</strong>ue <strong>to</strong> rate Enron a Buy based on strong growth prospects <strong>in</strong> globalwholesale/retail energy bus<strong>in</strong>esses, [<strong>and</strong>] the longer-term but high potential <strong>of</strong>Enron's broadb<strong>and</strong> communications strategy .... Earn<strong>in</strong>gs Rise 26% ... <strong>in</strong>crease <strong>in</strong>per share earn<strong>in</strong>gs <strong>to</strong> $0.34 per share ... above the $0.32 consensus.* * *Blockbuster Content Delivery Agreement.... Full scale roll-up is expected <strong>in</strong> 2001.The agreement has <strong>to</strong> be viewed as a strong endorsement <strong>of</strong> Enron's contentdelivery capabilities <strong>in</strong> video stream<strong>in</strong>g technology.251. This report is especially significant. CIBC was <strong>in</strong> Braveheart – the VOD jo<strong>in</strong>t venture withEnron – <strong>and</strong> thus knew the project was fail<strong>in</strong>g due <strong>to</strong> both content <strong>and</strong> technology problems <strong>and</strong>would not achieve a "full scale rollout" <strong>in</strong> 2001.In 10/00, Enron's s<strong>to</strong>ck began <strong>to</strong> decl<strong>in</strong>e from its all-time high, pierc<strong>in</strong>g the first equity triggerissuance price, CIBC moved <strong>to</strong> "defend" the s<strong>to</strong>ck, i.e., <strong>to</strong> help support it <strong>and</strong> stem the decl<strong>in</strong>e. On10/19/00, CIBC issued a report on Enron. It rated Enron a "Buy," with a $95 price target, <strong>and</strong>forecast 00, 01, <strong>and</strong> 02 EPS <strong>of</strong> $1.42, $1.65 <strong>and</strong> $1.95 for Enron. It also stated:269.Enron delivered another strong quarter, post<strong>in</strong>g strong year-over-year ga<strong>in</strong>s <strong>in</strong>Wholesale Energy as well as Retail Energy Services (EES). Fully diluted EPS(recurr<strong>in</strong>g) <strong>in</strong>creased 26% <strong>to</strong> $0.34 ... ahead <strong>of</strong> our ... estimate .... We arema<strong>in</strong>ta<strong>in</strong><strong>in</strong>g our BUY rat<strong>in</strong>g <strong>and</strong> 12-month target <strong>of</strong> $95 per share.* * *[EES] [r]eported IBIT <strong>of</strong> $30 million versus an $18 million loss a year ago on a172% <strong>in</strong>crease <strong>in</strong> revenues <strong>to</strong> $1.5 billion, up from $542 million a year ago. Dur<strong>in</strong>gthe quarter $4.1 billion <strong>of</strong> new contracts were recorded, <strong>in</strong>clud<strong>in</strong>g a $1 billion, 10-year agreement with Starwood Hotels <strong>and</strong> Resorts.- 89 -
The statements made <strong>in</strong> the three analysts' reports issued by CIBC between 4/12/00-10/19/00,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.- 90 -
(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> DSM contracts, which bundled 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> companieslike J.C. Penney, Quaker Oats, IBM, Starwood Properties, Albertsons, Safeway <strong>and</strong> others, alongwith long-term management <strong>and</strong> consult<strong>in</strong>g services on the cus<strong>to</strong>mers' usage <strong>of</strong> the power over thelife <strong>of</strong> the contract. Enron booked 100% <strong>of</strong> the commodity portion <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 contractwere pulled <strong>in</strong><strong>to</strong> the s<strong>in</strong>gle quarter when the contract was signed 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>g DSM transactions <strong>to</strong> show growth <strong>in</strong> EES'srevenues <strong>and</strong> pr<strong>of</strong>its.(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 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 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. 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.- 91 -
(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 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, that such revenue <strong>and</strong> pr<strong>of</strong>itforecasts <strong>and</strong> valuations were arbitrary, unreasonable <strong>and</strong> unobta<strong>in</strong>able.(j)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 successful broadb<strong>and</strong>based VOD system – <strong>in</strong> cable-quality digital format. Second, due <strong>to</strong> technical problems with itsbroadb<strong>and</strong> network, Enron could not transmit movies or other content with sufficient quality orspeed <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 unrealisticprojection <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.(k)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.(l)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, 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>ess- 92 -
operations 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.By mid-3/01, Enron had <strong>to</strong> ab<strong>and</strong>on the Blockbuster VOD jo<strong>in</strong>t venture <strong>and</strong> its s<strong>to</strong>ck wasfall<strong>in</strong>g sharply – pierc<strong>in</strong>g more equity issuance price triggers. Aga<strong>in</strong>, CIBC moved <strong>to</strong> defend thes<strong>to</strong>ck – <strong>to</strong> try <strong>to</strong> stem its decl<strong>in</strong>e <strong>and</strong> prevent the Ponzi scheme from unravel<strong>in</strong>g.On 4/19/01, CIBC issued a report on Enron. It rated Enron a "Buy" <strong>and</strong> <strong>in</strong>creased Enron'sforecasted 01 <strong>and</strong> 02 EPS <strong>to</strong> $1.78 <strong>and</strong> $2.05. It also stated:323.Enron Energy Services – Reported EBIT <strong>of</strong> $40 million compared <strong>to</strong> a 6 million <strong>in</strong>Q1/00. Revenues for this high-growth segment <strong>in</strong> the current quarter were $693million, up from $314 million a year ago. Total contract<strong>in</strong>g <strong>in</strong> the first quarter<strong>in</strong>creased <strong>to</strong> $5.9 billion....Enron Broadb<strong>and</strong> Energy Services – ... EBS has completed 580 transactions, whichrepresents more transaction than completed <strong>in</strong> all <strong>of</strong> 2000. Further there were 70new cus<strong>to</strong>mers who were added, br<strong>in</strong>g<strong>in</strong>g the <strong>to</strong>tal <strong>to</strong> 120.On 7/13/01, CIBC issued a report on Enron. It rated Enron a "Buy" <strong>and</strong> <strong>in</strong>creased Enron'sforecasted 01 <strong>and</strong> 02 EPS <strong>to</strong> $1.80 <strong>and</strong> $2.15. It also stated:334.Enron delivered another quarter <strong>of</strong> solid performance driven by strong resultsfrom wholesale energy activities. Enron reported an <strong>in</strong>crease <strong>in</strong> fully diluted EPS(recurr<strong>in</strong>g) <strong>of</strong> 32% <strong>to</strong> $0.45 per share, up from $0.34 <strong>in</strong> Q2/00. We are ma<strong>in</strong>ta<strong>in</strong><strong>in</strong>gour BUY rat<strong>in</strong>g .... Management also reiterated its confidence <strong>in</strong> meet<strong>in</strong>g theguidance <strong>of</strong> $1.80 <strong>in</strong> earn<strong>in</strong>gs for the full year 2001 <strong>and</strong> provided new guidanceon fiscal year 2002 <strong>of</strong> 2.15 per share. We are <strong>in</strong>creas<strong>in</strong>g our estimates <strong>to</strong> reflectmanagement guidance <strong>and</strong> prospects <strong>in</strong> wholesale <strong>and</strong> retail energy markets.The statements made <strong>in</strong> the two analysts' reports issued by CIBC between 4/19/01-7/13/01,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,- 93 -
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 artificially boosted itsf<strong>in</strong>ancial results.(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 knew it 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> makethem more <strong>and</strong> more attractive <strong>to</strong> generate new clients, while the Company utilized unrealistic- 94 -
projections <strong>and</strong> mark-<strong>to</strong>-market account<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 contractswere mak<strong>in</strong>g money.(g)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 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.(h)To <strong>in</strong>flate the purported revenues <strong>of</strong> its EBS operations, Enron was engag<strong>in</strong>g<strong>in</strong> transactions <strong>in</strong>volv<strong>in</strong>g so-called dark fiber – unlit broadb<strong>and</strong>-transmission capability – recogniz<strong>in</strong>gsignificant revenue on these transactions when, <strong>in</strong> fact, they were artificial contrivances known as"dark-fiber swaps," which <strong>in</strong>volved no real economic substance, but were simply a swap <strong>of</strong> Enron'sdark-fiber capacity with some counterparty for its dark-fiber capacity.(i)Enron exacerbated the manipulative <strong>and</strong> deceptive f<strong>in</strong>ancial impact <strong>of</strong> darkfiberswaps by account<strong>in</strong>g for the revenue or payment it received from the counterparty that boughtdark fiber from Enron as current-period revenue while, at the same time, Enron was capitaliz<strong>in</strong>gthe amounts it paid <strong>to</strong> that party <strong>to</strong> buy dark fiber from it on the other side <strong>of</strong> the swap. Thus, Enronavoided recogniz<strong>in</strong>g the expense <strong>of</strong> that purchase <strong>in</strong> the current period <strong>and</strong> <strong>in</strong>stead, amortized it overmany, many years – a deliberate account<strong>in</strong>g manipulation where revenue <strong>and</strong> expense were mismatched<strong>to</strong> <strong>in</strong>flate current-period results.(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 Enron knew from current problems <strong>in</strong> that bus<strong>in</strong>ess, as well as thecurrent state <strong>of</strong> EBS bus<strong>in</strong>ess, that such revenue <strong>and</strong> pr<strong>of</strong>it forecasts <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> the- 95 -
manner 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. Enron grossly overstated the number <strong>of</strong> trades be<strong>in</strong>g conducted by its broadb<strong>and</strong><strong>in</strong>termediation <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 bysplitt<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 even more separate trades, thuscreat<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)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.(n)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.(o)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, 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>ess- 96 -
operations 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. 339.By 8/00, Enron's s<strong>to</strong>ck was cont<strong>in</strong>u<strong>in</strong>g <strong>to</strong> fall <strong>and</strong> pierce more equity issuance trigger prices,when Enron's CEO Skill<strong>in</strong>g resigned, putt<strong>in</strong>g more pressure on the s<strong>to</strong>ck <strong>and</strong> plac<strong>in</strong>g thecont<strong>in</strong>uation <strong>of</strong> the scheme <strong>in</strong> real jeopardy. On 8/15/01, CIBC issued a report on Enron <strong>to</strong> try <strong>to</strong>defend Enron <strong>and</strong> support the s<strong>to</strong>ck. It cont<strong>in</strong>ued <strong>to</strong> rate Enron a "Buy" <strong>and</strong> forecast 01 <strong>and</strong> 02 EPS<strong>of</strong> $1.80 <strong>and</strong> $2.15 for Enron. It also stated:349.Leadership Change: The current President <strong>and</strong> CEO <strong>of</strong> Enron Corp., Jeff Skill<strong>in</strong>gannounced his resignation effective <strong>to</strong>day. The reason for his departure was cited as"personal concerns" <strong>and</strong> not related <strong>to</strong> Enron's current or expected performance....In discuss<strong>in</strong>g the leadership change <strong>in</strong> a conference call after yesterday's close, KenLay <strong>and</strong> Jeff Skill<strong>in</strong>g re-iterated their confidence <strong>in</strong> the Enron bus<strong>in</strong>ess model <strong>and</strong>assured <strong>in</strong>ves<strong>to</strong>rs the management change was not related <strong>to</strong> f<strong>in</strong>ancial oroperat<strong>in</strong>g performance.The statements made surround<strong>in</strong>g <strong>and</strong> after Skill<strong>in</strong>g's resignation by CIBC <strong>in</strong> its analysts'report 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," butrather, because he knew that the scheme <strong>to</strong> defraud he had been actively participat<strong>in</strong>g <strong>in</strong> was fall<strong>in</strong>gapart <strong>and</strong> about <strong>to</strong> be exposed, which would result <strong>in</strong> Enron's s<strong>to</strong>ck price completely 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 thatEnron had never been <strong>in</strong> better shape, its numbers looked good, there were no changes <strong>in</strong> Enron'searn<strong>in</strong>gs outlook, that the Company was very strong <strong>and</strong> the resignation did not signal anyaccount<strong>in</strong>g problems or adverse disclosures were all lies as, <strong>in</strong> fact, Enron's bus<strong>in</strong>ess – which hadbeen propped up through a series <strong>of</strong> manipulative or deceptive devices <strong>and</strong> contrivances for years– was now on the verge <strong>of</strong> complete collapse, due <strong>to</strong> the accumulated weight <strong>of</strong> the falsification <strong>of</strong>its f<strong>in</strong>ancial results. 359.On 10/16/01, Enron shocked <strong>in</strong>ves<strong>to</strong>rs by reveal<strong>in</strong>g huge losses <strong>and</strong> shareholder equitywritedowns. Enron's s<strong>to</strong>ck was plung<strong>in</strong>g ever lower – <strong>to</strong> levels that now threatened <strong>to</strong> result <strong>in</strong> acollapse <strong>of</strong> the house <strong>of</strong> cards. CIBC aga<strong>in</strong> slipped forward, desperately try<strong>in</strong>g <strong>to</strong> support the s<strong>to</strong>ckprice <strong>to</strong> try <strong>to</strong> stave <strong>of</strong>f a complete collapse <strong>of</strong> the Ponzi scheme.- 97 -
On 10/17/01, CIBC issued a report on Enron. The report rated Enron a "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 also stated:372.Enron met expectations despite lower contributions from regulated assets aswholesale energy services delivered another quarter <strong>of</strong> solid performance. Enronreported an <strong>in</strong>crease <strong>in</strong> fully diluted EPS (recurr<strong>in</strong>g) <strong>of</strong> 26% <strong>to</strong> $0.43 per share, upfrom $0.34 <strong>in</strong> Q3/00.The statements <strong>in</strong> CIBC's 10/17/01 analysts' report were false <strong>and</strong> mislead<strong>in</strong>g. The true factswere that Enron's operat<strong>in</strong>g earn<strong>in</strong>gs for the 3rdQ 01 as reported were artificially <strong>in</strong>flated, asdetailed here<strong>in</strong>, <strong>in</strong> part because <strong>of</strong> the huge dark-fiber swap transaction with Qwest; the write-<strong>of</strong>fstaken 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 shareholder equity wasstill overstated by $1-$2 billion <strong>and</strong> Enron's previously reported earn<strong>in</strong>gs were grotesquely false asdetailed 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> $2.15for Enron were also completely false as there was no basis whatsoever for these forecasts 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>g losses which wereactually <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 was extraord<strong>in</strong>arilyendangered. 390.All <strong>of</strong> CIBC's analyst reports on Enron issued after 12/99 were false <strong>and</strong> mislead<strong>in</strong>g for anadditional reason. After LJM2 was formed <strong>and</strong> CIBC had secretly pre-funded LJM2 <strong>and</strong> beenpermitted <strong>to</strong> <strong>in</strong>vest <strong>in</strong> LJM2 <strong>to</strong> the tune <strong>of</strong> over $15 million, <strong>and</strong> CIBC <strong>and</strong> engaged <strong>in</strong> the Braveheart<strong>and</strong> Hawaii 125-0 transactions with Enron – all <strong>of</strong> which created hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong>phony pr<strong>of</strong>its for Enron while hid<strong>in</strong>g billions <strong>of</strong> its debts, CIBC cont<strong>in</strong>ued <strong>to</strong> issue very positiveanalyst reports on Enron. Each <strong>of</strong> these reports conta<strong>in</strong>ed "boilerplate" disclosures like the one <strong>in</strong>this 10/13/99 CIBC report on Enron:A CIBC World Markets company or its shareholders, direc<strong>to</strong>rs, <strong>of</strong>ficers <strong>and</strong>/oremployees, may have a long or short position or deal as pr<strong>in</strong>cipal <strong>in</strong> the securitiesdiscussed here<strong>in</strong>, related securities or <strong>in</strong> options, futures or other derivative<strong>in</strong>struments based thereon. A CIBC World Markets company may have acted as<strong>in</strong>itial purchaser or placement agent for a private placement <strong>of</strong> any <strong>of</strong> the securities<strong>of</strong> any company mentioned <strong>in</strong> this report, may from time <strong>to</strong> time solicit from orperform f<strong>in</strong>ancial advisory, <strong>in</strong>vestment bank<strong>in</strong>g or other services for such company,or have lend<strong>in</strong>g or other credit relationships with the same.- 98 -
After 12/99, this boilerplate disclaimer <strong>in</strong> CIBC's reports on Enron did not change at all.These boilerplate disclosures were the same as they were before 12/99 – i.e., they did not changeafter CIBC <strong>in</strong>vested <strong>in</strong> LJM2 or engaged <strong>in</strong> the bogus Braveheart <strong>and</strong> Hawaii 125-0 transactionswith Enron, which enabled Enron <strong>to</strong> report hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> bogus pr<strong>of</strong>its <strong>and</strong>hide huge amounts <strong>of</strong> debt. 51 The failure <strong>to</strong> disclose the LJM2 <strong>in</strong>vestments <strong>of</strong> CIBC or CIBC's<strong>in</strong>volvement <strong>in</strong> the Braveheart or Hawaii 125-0 transactions made its "boilerplate" disclosures false<strong>and</strong> mislead<strong>in</strong>g <strong>and</strong> concealed from the market the very significant <strong>and</strong> serious conflict <strong>of</strong> <strong>in</strong>terestswhich Enron <strong>and</strong> CIBC knew would have cast serious doubts on the objectivity <strong>and</strong> honesty <strong>of</strong>CIBC's analyst reports on Enron <strong>and</strong> disclosed that CIBC 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. 29, 725-734.The Registration Statements CIBC used <strong>to</strong> sell 27.6 million shares <strong>of</strong> Enron s<strong>to</strong>ck at $31.34<strong>in</strong> 2/99 <strong>and</strong> $500 million <strong>in</strong> 7.375% notes <strong>in</strong> 5/99 were false <strong>and</strong> mislead<strong>in</strong>g due <strong>to</strong> the <strong>in</strong>corporation<strong>of</strong> Enron's 97-98 10-Ks <strong>and</strong> 98 10-Qs that conta<strong>in</strong>ed Enron's admittedly false f<strong>in</strong>ancial statementsfor 97-98, which understated Enron's debt by billions <strong>of</strong> dollars <strong>and</strong> overstated its earn<strong>in</strong>gs byhundreds <strong>of</strong> millions <strong>of</strong> dollars, as detailed <strong>in</strong> 418-611 <strong>of</strong> the CC. While their RegistrationStatements <strong>in</strong>cluded audited annual f<strong>in</strong>ancial statements, significantly, they 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> the respective <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 unaudited f<strong>in</strong>ancial false <strong>and</strong>mislead<strong>in</strong>g unaudited quarter f<strong>in</strong>ancial results. 612. 52 Of course, s<strong>in</strong>ce the <strong>in</strong>terim 98 f<strong>in</strong>ancialstatements were unaudited <strong>and</strong> were not expertised CIBC is responsible for them.CIBC also made false <strong>and</strong> mislead<strong>in</strong>g statements <strong>in</strong> the Registration Statement used by Enron<strong>to</strong> sell New 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>to</strong> create a bogus$370 million pr<strong>of</strong>it. Thus, the successful completion <strong>of</strong> the IPO was a key part <strong>of</strong> the ongo<strong>in</strong>g Enron51Copies <strong>of</strong> relevant pages from pre-<strong>and</strong> post-12/99 CIBC analyst reports are attached as Ex. 9<strong>to</strong> pla<strong>in</strong>tiffs' Appendix.52While CIBC may be able at trial <strong>to</strong> establish a defense <strong>to</strong> liability for these expertised, i.e.,certified f<strong>in</strong>ancial statements, <strong>in</strong> light <strong>of</strong> the CC's allegations that CIBC knew those annual certifiedf<strong>in</strong>ancial statements were false, CIBC may not do so now at the 12b-6 stage. Murphy, 1996 U.S.Dist. LEXIS 22207, at *23.- 99 -
scheme <strong>to</strong> defraud <strong>in</strong>volv<strong>in</strong>g Enron. New Power was purportedly a nationwide provider <strong>of</strong> electricalpower <strong>and</strong> natural gas <strong>to</strong> retail consumers. New Power was formed by Enron <strong>in</strong> 99 <strong>and</strong> controlledby it. The New Power Registration Statement represented that New Power could succeed <strong>in</strong> avolatile energy market (where other similar companies had failed) through sophisticated riskmanagement strategies conceived <strong>and</strong> managed by its affiliate, EES. In truth <strong>and</strong> <strong>in</strong> fact, neither EESnor New Power had any hedg<strong>in</strong>g strategies which could enable New Power <strong>to</strong> operate pr<strong>of</strong>itablyunder market conditions prevail<strong>in</strong>g 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, aNew Power direc<strong>to</strong>r, that EES had failed 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>gcontracts as ga<strong>in</strong>s.The New Power Registration Statement repeatedly emphasized the skill <strong>and</strong> expertise Enronwould provide <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>hedge aga<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> risk management expertise, <strong>and</strong> reliable wholesale commoditypurchas<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. 53 The New Power IPO proceeds53Because 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- 100 -
<strong>of</strong> $543 million were purportedly sufficient for New Power <strong>to</strong> carry forward its bus<strong>in</strong>ess plan for atleast 24 months. Given the conditions <strong>in</strong> the energy markets, <strong>and</strong> the his<strong>to</strong>ry <strong>of</strong> EES, CIBC knewthat such proceeds could not carry New Power through one year <strong>of</strong> successful operations, let alone24 months.As a result <strong>of</strong> these misrepresentations <strong>and</strong> omissions, Enron was able <strong>to</strong> sell New Powershares at an IPO price <strong>of</strong> $21 per share, allow<strong>in</strong>g Enron <strong>to</strong> create <strong>and</strong> record a bogus $370 millionpr<strong>of</strong>it! As the true nature <strong>of</strong> New Power's bus<strong>in</strong>ess operations was revealed over the course <strong>of</strong> thenext few months, its s<strong>to</strong>ck price collapsed. On 12/5/01, New Power announced that its contractswith Enron had been term<strong>in</strong>ated. On 2/20/02, New Power publicly admitted <strong>in</strong> substance that it wasunable <strong>to</strong> operate as an <strong>in</strong>dependent company. By 2/26/02, the New Power s<strong>to</strong>ck s<strong>to</strong>od at only 90cents per share!VII.CIBC ACTED WITH SCIENTER, I.E., WITH "THE REQUIRED STATEOF 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 AFRAUDULENT SCHEME OR COURSE OF BUSINESS THATOPERATED AS A FRAUD OR DECEIT ON PURCHASERS OF ENRONSECURITIESCIBC can claim neither ignorance nor <strong>in</strong>nocence with respect <strong>to</strong> the Enron debacle. 54 CIBChad an extensive <strong>and</strong> extremely close relationship with Enron, dur<strong>in</strong>g which it ga<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> commercial loans<strong>and</strong> lend<strong>in</strong>g commitments <strong>of</strong> over $4.2 billion <strong>to</strong> Enron. CIBC also helped raise over $2.3 billionfor Enron via four sales <strong>of</strong> Enron <strong>and</strong> Enron-related securities, sales <strong>of</strong>ten accomplished via falseRegistration Statements. CIBC's relationships with Enron were so extensive that <strong>to</strong>p <strong>of</strong>ficials <strong>of</strong> thebank 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 the Class Period, discuss<strong>in</strong>g Enron's<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.54Because CIBC sold Enron securities pursuant <strong>to</strong> false <strong>and</strong> mislead<strong>in</strong>g registration statements,it faces 1933 Act §11 liability as <strong>to</strong> which no scienter is required. See supra at 27.- 101 -
us<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.CIBC 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, CIBC helpedstructure <strong>and</strong> fund several <strong>of</strong> Enron's secretly controlled partnerships – <strong>in</strong>clud<strong>in</strong>g LJM2 <strong>and</strong> its SPEs– <strong>to</strong> facilitate illicit <strong>and</strong> contrived SPE transactions 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> CIBC'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> otherpayments from Enron <strong>and</strong> related entities. CIBC was also permitted <strong>to</strong> <strong>in</strong>vest $15 million <strong>in</strong> Enron'slucrative LJM2 partnership as a reward <strong>to</strong> it for its participation <strong>in</strong> this fraud, allow<strong>in</strong>g it <strong>to</strong> directlypr<strong>of</strong>it from the loot<strong>in</strong>g <strong>of</strong> Enron that <strong>to</strong>ok place via the repeated non-arm's-length fraudulentLJM2/SPE transactions with Enron, transactions which it knew could cont<strong>in</strong>ue only if Enron's s<strong>to</strong>ckcont<strong>in</strong>ued <strong>to</strong> trade at high prices – above the so-called equity issuance trigger prices <strong>in</strong> theLJM2/SPE deals. 618-621, 724, 732. At the same time, CIBC's securities analysts were issu<strong>in</strong>gextremely 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>esssuccess, the strength <strong>of</strong> its f<strong>in</strong>ancial condition <strong>and</strong> its prospects for strong revenue <strong>and</strong> earn<strong>in</strong>gsgrowth, help<strong>in</strong>g <strong>to</strong> push Enron's s<strong>to</strong>ck higher. As alleged, this is <strong>in</strong>tentional participation <strong>in</strong> thefraud.Thus, CIBC 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 <strong>and</strong>, <strong>in</strong> so do<strong>in</strong>g, engaged <strong>in</strong> contrivances <strong>and</strong> devices <strong>to</strong> deceive <strong>and</strong> made repeatedfalse <strong>and</strong> mislead<strong>in</strong>g statements. CIBC also created <strong>and</strong> funded the bogus Hawaii 125-0 <strong>and</strong>Braveheart deals(receiv<strong>in</strong>g secret no-loss guarantees from Enron) generat<strong>in</strong>g $480 million <strong>in</strong> phonypr<strong>of</strong>its for Enron – direct participation <strong>in</strong> the falsification <strong>of</strong> Enron's f<strong>in</strong>ancial condition, liquidity<strong>and</strong> creditworth<strong>in</strong>ess. CIBC also "pre-funded" LJM2 on 12/2/299 with $2.25 million, which fundedfour 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. CIBC cont<strong>in</strong>ued<strong>to</strong> fund LJM2 dur<strong>in</strong>g 00-01, with more secret equity money <strong>to</strong> enable LJM2 <strong>to</strong> engage <strong>in</strong> repeatednon-arm's-length deals with Enron <strong>to</strong> artificially boost its pr<strong>of</strong>its by hundreds <strong>of</strong> million <strong>of</strong> dollarswhile hid<strong>in</strong>g billions <strong>of</strong> debt – deceiv<strong>in</strong>g the securities markets. Dur<strong>in</strong>g 00-01, CIBC enjoyed thelush 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 – <strong>in</strong>clud<strong>in</strong>g CIBC. CIBC alsoengaged <strong>in</strong> the New Power IPO, help<strong>in</strong>g <strong>to</strong> structure <strong>and</strong> fund an SPE deal creat<strong>in</strong>g a huge phony- 102 -
$370 million pr<strong>of</strong>it for Enron <strong>in</strong> 10/00 – further artificially <strong>in</strong>flat<strong>in</strong>g Enron's pr<strong>of</strong>its <strong>and</strong> hid<strong>in</strong>g moredebt. Aga<strong>in</strong>, as alleged <strong>in</strong> the CC, this is <strong>in</strong>tentional participation <strong>in</strong> the falsification <strong>of</strong> Enron'sf<strong>in</strong>ancial results <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 CIBC, 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 CIBC.While the CC alleges that CIBC made false <strong>and</strong> mislead<strong>in</strong>g statements <strong>in</strong> registration statements <strong>and</strong>analyst reports, CIBC's liability is not limited <strong>to</strong> those allegedly false <strong>and</strong> mislead<strong>in</strong>g statements.The CC also alleges CIBC's liability for its conduct <strong>in</strong> participat<strong>in</strong>g <strong>in</strong> the scheme <strong>to</strong> defraud orcourse <strong>of</strong> bus<strong>in</strong>ess that operated as a fraud <strong>and</strong> deceit on purchasers <strong>of</strong> Enron publicly tradedsecurities. This dist<strong>in</strong>ction is important because if the CC fails <strong>to</strong> adequately allege the falsity <strong>of</strong>CIBC's own statements or CIBC's knowledge or reckless disregard <strong>of</strong> the falsity <strong>of</strong> those statements,the CC may still adequately allege that CIBC know<strong>in</strong>gly or recklessly employed deceptive acts orparticipated <strong>in</strong> the fraudulent scheme or course <strong>of</strong> bus<strong>in</strong>ess or vice versa. These are dist<strong>in</strong>ct liabilitytheories – one based on statements – the other based on conduct, which can result <strong>in</strong> liability, either<strong>in</strong> comb<strong>in</strong>ation or 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., either <strong>in</strong>tentional or reckless conduct. Thus, with respect <strong>to</strong> CIBC's allegeddeceptive acts <strong>and</strong> participation <strong>in</strong> the fraudulent scheme or course <strong>of</strong> bus<strong>in</strong>ess, scienter would beadequately 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,CIBC acted with the "required state <strong>of</strong> m<strong>in</strong>d," i.e., it acted <strong>in</strong>tentionally or recklessly. This wouldbe so even if CIBC had no knowledge that its own statements <strong>in</strong> analysts' reports or RegistrationStatements were false <strong>and</strong> mislead<strong>in</strong>g, for as this Court has recognized, it is not necessary that adefendant have 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.- 103 -
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. 55 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., No. 3:98:CV-0161-L, 2001 U.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 195).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); United55Pla<strong>in</strong>tiffs 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 shouldbe resolved <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.").- 104 -
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). 56Scheme <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. Nat'l Bankers Life Ins. Co., 324 F. Supp. 189,194-95 (N.D. Tex. 1971), aff'd, 448 F.2d 652 (5th Cir. 1971) (same). 57 A scheme <strong>to</strong> defraud is a56As 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)(footnote omitted).Pla<strong>in</strong>tiffs cite these conspiracy cases not because they allege conspiracy liability here – they do not.However, s<strong>in</strong>ce scheme liability is expressly provided for by the language <strong>of</strong> §10(b)/Rule 10b-5 <strong>and</strong>the extent <strong>of</strong> the scheme liability is at least as broad a conspiracy liability would be these conspiracycases are useful <strong>in</strong> determ<strong>in</strong><strong>in</strong>g the parameters <strong>of</strong> scheme liability.57Similarly, 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.- 105 -
unitary violation, such that the pla<strong>in</strong>tiff need not prove transaction causation with respect <strong>to</strong> anyparticular misrepresentations or omissions or other components <strong>of</strong> the scheme. See Shores, 647 F.2dat 469, 472 ("The concept <strong>of</strong> [a] scheme <strong>to</strong> defraud satisfies the requirement <strong>of</strong> 'transactioncausation' .... It has as its core objective that the potential victim engage <strong>in</strong> the transaction for whichthe scheme was conceived."); 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 needonly be shown that market relied on overall fraudulent scheme rather than on <strong>in</strong>dividual statementsor omissions).Nat'l Bankers Life, 324 F. Supp. 189 – a pre-Central Bank case – recognized that 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> thescheme. In that case, the SEC brought an action aga<strong>in</strong>st 28 defendants for participat<strong>in</strong>g <strong>in</strong> aconspiracy <strong>to</strong> defraud <strong>and</strong> a scheme <strong>to</strong> defraud. See id. at 193-94. S<strong>in</strong>ce this was a pre-Central Bankcase, the SEC did not focus on the difference between conspiracy <strong>and</strong> scheme liability, treat<strong>in</strong>g themessentially as synonymous, <strong>and</strong> the court did not focus on the difference 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 asaiders <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 consideredthe 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 wellhave considered it under the rubric <strong>of</strong> primary liability. Nevertheless, the important po<strong>in</strong>t is thecourt's recognition that co-schemers may be liable for all aspects <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. at §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 issubject <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 commondesign with him ...."); id. at §876, Comment 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.").- 106 -
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).Id.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> Nat'l Bankers Life <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 ...."). 5858In 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 Nu-kote'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> thedefendants 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 4 th Q <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.- 107 -
In evaluat<strong>in</strong>g the CC's allegations that CIBC employed acts <strong>and</strong> manipulative or deceptivedevices <strong>and</strong> contrivances, <strong>and</strong> participated <strong>in</strong> a fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess, it isimportant <strong>to</strong> focus on the type <strong>of</strong> actions CIBC has alleged <strong>to</strong> have committed <strong>in</strong> furtherance <strong>of</strong> thealleged fraudulent scheme or course <strong>of</strong> bus<strong>in</strong>ess. For <strong>in</strong>stance, the phony Braveheart <strong>and</strong> Hawaii125-0 transactions by their very nature <strong>in</strong>volve <strong>in</strong>tentional conduct. These multi-billion dollar,highly structured transactions which CIBC entered <strong>in</strong><strong>to</strong> with Enron SPEs <strong>to</strong> enable Enron <strong>to</strong> boostits reported results, could not have been the result <strong>of</strong> negligence or ignorance. Why do these dealsbut then contrive the transactions <strong>to</strong> accept secret no-loss guarantees from Enron unless the purposewas <strong>to</strong> conceal <strong>and</strong> deceive, as alleged?In this regard, CIBC participated <strong>in</strong> the pre-fund<strong>in</strong>g <strong>of</strong> LJM2 on 12/22/99 – putt<strong>in</strong>g up $2.25million before LJM2 was fully formed or funded <strong>and</strong> putt<strong>in</strong>g up much more money than its allocatedshare <strong>of</strong> LJM2's equity was or would have been – <strong>to</strong> f<strong>in</strong>ance four phony, non-arm's-length year-end99 deals with Enron, which were then all quickly unwound dur<strong>in</strong>g 00, with huge returns <strong>to</strong> theseLJM2 pre-funders. This 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> CIBC's liability under §10(b) <strong>and</strong> Rule 10b-5 for its own false <strong>and</strong> mislead<strong>in</strong>gstatements, it is necessary for the compla<strong>in</strong>t <strong>to</strong> plead specific facts rais<strong>in</strong>g a "strong <strong>in</strong>ference" thatCIBC knew the statements were false or acted <strong>in</strong> reckless disregard <strong>of</strong> their truth or falsity.However, <strong>in</strong> this regard, CIBC's alleged conduct <strong>and</strong> its participat<strong>in</strong>g <strong>in</strong> the fraudulent scheme orcourse <strong>of</strong> bus<strong>in</strong>ess rema<strong>in</strong> highly relevant, for those acts themselves can show CIBC's knowledge<strong>of</strong> the falsity – or its reckless disregard for the truth or falsity – <strong>of</strong> the statements it was mak<strong>in</strong>g.Aga<strong>in</strong>, CIBC's <strong>in</strong>volvement <strong>in</strong> LJM2 – where it helped pre-fund LJM2 on 12/22/99 with$2.25 million, <strong>to</strong> enable LJM2 <strong>to</strong> engage <strong>in</strong> non-arm's-length fraudulent transactions with Enron <strong>in</strong>the last days <strong>of</strong> 99 <strong>to</strong> create bogus <strong>in</strong>come <strong>and</strong> hide debt, shows that CIBC knew (or at leastrecklessly disregarded) that Enron's f<strong>in</strong>ancial statements were false <strong>and</strong> that its purported bus<strong>in</strong>essUnlike 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.- 108 -
success was not due <strong>to</strong> strong bus<strong>in</strong>ess conditions or the skill <strong>of</strong> its managers <strong>and</strong> the success <strong>of</strong> theirrisk management <strong>and</strong> hedg<strong>in</strong>g techniques, but rather <strong>to</strong> non-arm's-length fraudulent f<strong>in</strong>ancialtransactions with controlled entities. CIBC knew both because it was an <strong>in</strong>ves<strong>to</strong>r <strong>in</strong> LJM2 <strong>and</strong> wasadm<strong>in</strong>ister<strong>in</strong>g LJM2's affairs, i.e., distribut<strong>in</strong>g its pr<strong>of</strong>its <strong>to</strong> <strong>in</strong>ves<strong>to</strong>rs, that dur<strong>in</strong>g 00-01 LJM2 wasconstantly 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 partnership was 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 wereonly possible if the transactions 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 SEC that – upon review<strong>in</strong>g LJM2 documentsthat the returns the LJM2 <strong>in</strong>ves<strong>to</strong>rs got – it was immediately apparent <strong>to</strong> him – (a man who claims<strong>to</strong> lack f<strong>in</strong>ancial sophistication) – that those returns from the deals LJM2 was gett<strong>in</strong>g via SPE dealswith Enron were so huge – so lavish – that they had <strong>to</strong> be due <strong>to</strong> non-arm's-length fraudulenttransactions 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 thatsuch returns – which were as high as 2,500 percent <strong>in</strong> one transaction – could nothave been achieved through arm's-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. Had he known themagnitude <strong>of</strong> the pr<strong>of</strong>its, Mr. Skill<strong>in</strong>g was said <strong>to</strong> have <strong>to</strong>ld the regula<strong>to</strong>rs, hewould have immediately summoned Enron executives <strong>in</strong>volved <strong>in</strong> the deal<strong>in</strong>gs <strong>and</strong>given them 24 hours <strong>to</strong> justify such outsize results.Kurt Eichenwald, "Enron Ex-Chief Said <strong>to</strong> Voice Suspicions <strong>of</strong> Fraud," New York Times, 4/24/02. 5959If 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 CIBC, who were actually reap<strong>in</strong>g these fantastic returns, knewit all along.- 109 -
What does this testimony say about the knowledge <strong>of</strong> a f<strong>in</strong>ancially sophisticated bank likeCIBC's which was reap<strong>in</strong>g the very fruits <strong>of</strong> those fraudulent non-arm's-length LJM2transactions 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 CIBC, 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 was engag<strong>in</strong>g <strong>in</strong> with the LJM2SPEs <strong>to</strong> falsify its f<strong>in</strong>ancial results. Thus, CIBC was not only a know<strong>in</strong>g participant <strong>in</strong> the Enronscheme <strong>to</strong> defraud, it was a direct economic beneficiary <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 CIBC <strong>to</strong> be mak<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 strong economicperformance <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 the next severalyears <strong>and</strong> without any disclosure <strong>of</strong> its <strong>in</strong>volvement <strong>in</strong> LJM2 unless CIBC was deliberately ly<strong>in</strong>g orhad 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 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" wasadequately pleaded. The key allegation was that CIBC 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 <strong>to</strong> Livent, as CIBC had asecret side agreement from Livent <strong>to</strong> "repurchase" the 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 Liventimproperly recorded <strong>in</strong>come on the transaction, but did not record the loan. The district court heldscienter 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>- 110 -
Id. at 151-54.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 fraudulentarrangement were reported by Livent as current revenue <strong>in</strong> its accounts <strong>and</strong> publicregistration statements <strong>in</strong> order [<strong>to</strong>][sic] 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.* * *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>vestmentbanker 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.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 secretloan 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> a- 111 -
secret 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> a new company called New Power (731); aga<strong>in</strong>, CIBC was privy <strong>to</strong> <strong>in</strong>formation, onemust <strong>in</strong>fer, that made CIBC aware that Enron's reported f<strong>in</strong>ancial condition was not its "real f<strong>in</strong>ancialcondition." Like the court <strong>in</strong> Livent, this Court should also f<strong>in</strong>d that the <strong>in</strong>vestment bank defendanthere acted with scienter <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 is liable for participation <strong>in</strong> a fraudulent scheme.In evaluat<strong>in</strong>g the CC's allegations <strong>of</strong> knowledge on the part <strong>of</strong> CIBC, 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 CIBC, are very differentf<strong>in</strong>ancial <strong>in</strong>stitutions from the <strong>in</strong>vestment banks or commercial banks that may have been named asdefendants <strong>in</strong> prior securities cases. Until recent years, <strong>in</strong>vestment banks were not permitted <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> engage <strong>in</strong><strong>in</strong>vestment bank<strong>in</strong>g services. This was the essence <strong>of</strong> Glass-Steagall. However, when Glass-Steagall 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 banks named as defendants <strong>in</strong> this case hasimportant implications for the CC's allegations that they knew or were reckless <strong>in</strong> not know<strong>in</strong>g thatthe statements they were mak<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 thesebanks were mak<strong>in</strong>g huge commercial 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- 112 -
y Enron <strong>and</strong> related entities, they had more extensive <strong>and</strong> more constant contact with Enron's <strong>to</strong>pexecutives <strong>and</strong> access <strong>to</strong> Enron's non-public f<strong>in</strong>ancial records, performance <strong>and</strong> plans than wouldhave been the case had they only come periodically <strong>in</strong><strong>to</strong> contact with Enron <strong>to</strong> act as an underwriter<strong>to</strong> sell securities <strong>to</strong> the public.Dur<strong>in</strong>g the Class Period, CIBC was a major lender <strong>to</strong> Enron, be<strong>in</strong>g <strong>in</strong>volved <strong>in</strong> over $4billion <strong>in</strong> loans or lend<strong>in</strong>g commitments. In mak<strong>in</strong>g large commercial loans or commitments asCIBC did <strong>to</strong> Enron, CIBC was 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>ancialcondition <strong>and</strong> creditworth<strong>in</strong>ess <strong>of</strong> the borrower, not only at the outset when the loan, is made butconstantly throughout the pendency <strong>of</strong> the loan or lend<strong>in</strong>g commitment. Obviously, the larger thesize <strong>of</strong> the loan or loan commitment, the greater the amount <strong>of</strong> f<strong>in</strong>ancial analysis oversight <strong>and</strong>review required.Thus, CIBC was required <strong>to</strong> perform extensive credit analysis <strong>of</strong> Enron after obta<strong>in</strong><strong>in</strong>gdetailed f<strong>in</strong>ancial <strong>in</strong>formation from it. Included <strong>in</strong> this credit analysis was a detailed review <strong>of</strong> theEnron's actual <strong>and</strong> cont<strong>in</strong>gent liabilities, its liquidity position, any equity issuance obligations it mayhave which could adversely affect its shareholders' equity, any debt on which Enron may have beenpotentially liable, even if not on Enron's books directly, the quality <strong>of</strong> Enron's pr<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. Inaddition, after CIBC made large loans <strong>to</strong> or committed itself <strong>to</strong> credit facilities for a corporation, itwas required <strong>to</strong> closely moni<strong>to</strong>r Enron by frequently review<strong>in</strong>g its f<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 borrowerkeep 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 aresult, CIBC obta<strong>in</strong>ed extremely detailed <strong>in</strong>formation concern<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 the actual condition <strong>of</strong> Enron's bus<strong>in</strong>ess, itsf<strong>in</strong>ances <strong>and</strong> its f<strong>in</strong>ancial condition was far worse than was be<strong>in</strong>g publicly disclosed by Enron, or asdescribed or disclosed <strong>in</strong> each <strong>of</strong> CIBC's analyst reports on Enron. Thus, CIBC knew (or wasreckless <strong>in</strong> not know<strong>in</strong>g):- 113 -
(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 CIBC – <strong>and</strong>, at the same time, 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 itsbalance 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, Enron's true debt level <strong>and</strong> leverage wasmuch 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; <strong>and</strong>(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 CIBC was fund<strong>in</strong>g – while adm<strong>in</strong>ister<strong>in</strong>g its affairs – <strong>to</strong> f<strong>in</strong>ance thesetransactions, which would require Enron <strong>to</strong> issue millions <strong>of</strong> shares <strong>of</strong> Enron common s<strong>to</strong>ck. IfEnron's common s<strong>to</strong>ck fell below trigger prices rang<strong>in</strong>g from $83-$19 per share, not only wouldEnron 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 whichEnron was do<strong>in</strong>g bus<strong>in</strong>ess would not, <strong>in</strong> fact, be non-recourse <strong>to</strong> 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's credit rat<strong>in</strong>g was lowered –someth<strong>in</strong>g CIBC knew would occur if, as <strong>and</strong> when Enron's true f<strong>in</strong>ancial condition became publicor became known <strong>to</strong> the rat<strong>in</strong>g agencies.- 114 -
In addition <strong>to</strong> CIBC's extensive ongo<strong>in</strong>g commercial bank<strong>in</strong>g relationship with Enron – <strong>and</strong>the knowledge it ga<strong>in</strong>ed from that – CIBC also acted as an underwriter <strong>in</strong> four securities <strong>of</strong>fer<strong>in</strong>gs,rais<strong>in</strong>g $2.3 billion for Enron before <strong>and</strong> dur<strong>in</strong>g the Class Period.Thus, CIBC had constant access <strong>to</strong> Enron's <strong>to</strong>p executives <strong>and</strong> Enron's f<strong>in</strong>ancial records,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>/orlend<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 is not asituation <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 (i) 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; (ii) that was a major borrowerfrom the commercial operations <strong>of</strong> the bank which; (iii) via the bank's <strong>in</strong>vestment bank<strong>in</strong>goperations was sell<strong>in</strong>g securities <strong>of</strong> the company <strong>to</strong> the public which; (iv) was also constantlyissu<strong>in</strong>g analyst reports about that borrower/client <strong>to</strong> the public which the bank was structur<strong>in</strong>g<strong>and</strong> fund<strong>in</strong>g (Braveheart <strong>and</strong> Hawaii 125-O) <strong>to</strong> generate some $480 million <strong>in</strong> phony pr<strong>of</strong>its forthe Company; (v) while the bank was a secret <strong>in</strong>ves<strong>to</strong>r <strong>in</strong> a huge partnership (LJM2) which wasdo<strong>in</strong>g non-arm's-length fraudulent transactions with Enron which were generat<strong>in</strong>g hundreds <strong>of</strong>millions <strong>of</strong> dollars <strong>of</strong> phony pr<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, as its secret <strong>in</strong>vestment <strong>in</strong> the LJM2 partnershipbenefitted from the loot<strong>in</strong>g <strong>of</strong> Enron. With all due respect, this is a situation that has never beforebeen presented s<strong>in</strong>ce the passage <strong>of</strong> the federal securities laws <strong>in</strong> 1933-34 because only <strong>in</strong> recentyears have banks been able <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>gactivity 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 publicly traded securities.Contrary <strong>to</strong> CIBC's claims that it is protected by some "Ch<strong>in</strong>ese Wall" or that the knowledge<strong>of</strong> the entire CIBC corporate entity <strong>in</strong> <strong>in</strong>teract<strong>in</strong>g with Enron, CIBC functioned as an unified entity.There was no so-called "Ch<strong>in</strong>ese Wall" <strong>to</strong> seal <strong>of</strong>f the CIBC securities analysts from the <strong>in</strong>formationwhich CIBC 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.Alternatively, even if some restrictions on the <strong>in</strong>formation made available <strong>to</strong> CIBC's securities- 115 -
analysts existed, those unilateral <strong>and</strong> self-serv<strong>in</strong>g actions are <strong>in</strong>sufficient <strong>to</strong> prevent imputation <strong>of</strong>all knowledge <strong>and</strong> scienter possessed by the CIBC legal entity, as its knowledge <strong>and</strong> liability <strong>in</strong> thiscase is determ<strong>in</strong>ed by look<strong>in</strong>g at CIBC as an overall legal entity. 717. 60Knowledge 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.'" Am. St<strong>and</strong>ard Credit, Inc. v. Nat'l Cement 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, 61subsequent Fifth Circuit cases do appear <strong>to</strong> focus much more on the employee's position <strong>in</strong> thecompany. See In re Hellenic Inc., 252 F.3d 391, 395 (5th Cir. 2001) ("[W]e have observed that thequestion <strong>of</strong> 'privity or knowledge must turn on the facts <strong>of</strong> the <strong>in</strong>dividual case', stat<strong>in</strong>g that acorporation 'is charged with the privity or knowledge <strong>of</strong> its employees when they are sufficientlyhigh on the corporate ladder.' We have further expla<strong>in</strong>ed 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 scope60Any claimed "Ch<strong>in</strong>ese Wall" cannot provide a defense at the motion <strong>to</strong> dismiss stage.Cooper, 137 F.3d at 628-29.61"[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.- 116 -
<strong>of</strong> authority <strong>in</strong>cludes supervision over the phase <strong>of</strong> the bus<strong>in</strong>ess out <strong>of</strong> which the loss or <strong>in</strong>juryoccurred.'") (footnotes omitted).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. SeeBurzynski v. Aetna Life Ins. Co., No. H-89-3976, 1992 U.S. Dist. LEXIS 21300, at *13 (S.D. Tex.Apr. 1, 1992) ("[T]he knowledge <strong>of</strong> Aetna's agents <strong>and</strong> employees is imputed <strong>to</strong> the corporation- 117 -
under the doctr<strong>in</strong>e <strong>of</strong> 'collective knowledge.'") (cit<strong>in</strong>g Steere Tank L<strong>in</strong>es, Inc. v. United States, 330F.2d 719,722 (5th Cir. 1963)). 62Also, 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' 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.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. CIBC 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,62Additionally, <strong>in</strong> Am. St<strong>and</strong>ard Credit, 643 F.2d at 271 n.16, the Fifth Circuit stated: "'Thegeneral 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 notice or acquiresknowledge 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> his authority, eventhough the <strong>of</strong>ficer or agent does not <strong>in</strong> fact communicate his knowledge <strong>to</strong> the corporation.'"- 118 -
the proceeds <strong>of</strong> Enron's securities <strong>of</strong>fer<strong>in</strong>gs underwritten by CIBC or other <strong>in</strong>vestment banks wereutilized <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> CIBC. And throughout the Class Period, CIBC was pocket<strong>in</strong>g millions <strong>of</strong> dollars a year <strong>in</strong> <strong>in</strong>terestpayments, 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>and</strong>huge returns on its secret <strong>in</strong>vestment <strong>in</strong> LJM2 – returns created by the loot<strong>in</strong>g <strong>of</strong> Enron via the verymanipulative or deceptive acts <strong>and</strong> contrived transactions between Enron <strong>and</strong> LJM2 entities whichCIBC was f<strong>in</strong>anc<strong>in</strong>g <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 go<strong>in</strong>g forward,so long as it helped perpetuate the Enron Ponzi scheme. 646.CIBC was will<strong>in</strong>g <strong>to</strong> participate <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong> bus<strong>in</strong>ess because itsparticipation created enormous pr<strong>of</strong>its for CIBC as long as the Enron scheme cont<strong>in</strong>ued <strong>in</strong>operation – someth<strong>in</strong>g that CIBC was <strong>in</strong> a unique position <strong>to</strong> cause. While CIBC was lend<strong>in</strong>ghundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>to</strong> Enron or had 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 its coveted<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 forecast strongongo<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> enableEnron <strong>to</strong> raise hundreds <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 would be used <strong>to</strong> repay or reduce Enron's commercial paper debt <strong>and</strong> the loansfrom CIBC <strong>to</strong> Enron so that the scheme could cont<strong>in</strong>ue. 722.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 because that <strong>in</strong>flated s<strong>to</strong>ck price was the keysupport<strong>in</strong>g 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> CIBC <strong>in</strong> LJM2 was, bluntly put, a reward – a pay<strong>of</strong>f – for itsparticipation <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 as long asthe Enron Ponzi scheme could be cont<strong>in</strong>ued – generat<strong>in</strong>g huge returns for them as secret privateequity <strong>in</strong>ves<strong>to</strong>rs <strong>in</strong> LJM2 which returns were only possible because the transactions that werebe<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- 119 -
ogus 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 excessive returns forLJM2 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, CIBC which was <strong>in</strong>volved <strong>in</strong> LJM2, was engaged <strong>in</strong> loot<strong>in</strong>g Enron for its ownpersonal pr<strong>of</strong>it. This gave them a tremendous motive <strong>to</strong> keep Enron afloat <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> the capital markets <strong>to</strong> raisecapital <strong>to</strong> keep the Enron Ponzi scheme go<strong>in</strong>g. While the banks may now wh<strong>in</strong>e about the lossesthey claim <strong>to</strong> have suffered when the Enron Ponzi scheme collapsed, they were secretly rubb<strong>in</strong>g theirh<strong>and</strong>s <strong>in</strong> glee dur<strong>in</strong>g the years that the scheme succeeded <strong>and</strong> Enron was be<strong>in</strong>g looted while be<strong>in</strong>gpropped up with public money which was flow<strong>in</strong>g <strong>in</strong><strong>to</strong> their dirty h<strong>and</strong>s <strong>and</strong> then their own deeppockets.But the motive <strong>of</strong> the banks here <strong>to</strong> participate <strong>in</strong> the fraudulent scheme <strong>and</strong> course <strong>of</strong>bus<strong>in</strong>ess <strong>and</strong> make false statements about Enron's bus<strong>in</strong>ess <strong>and</strong> f<strong>in</strong>ancial condition goes far beyondthe huge motive provided by their LJM2 pr<strong>of</strong>its flow<strong>in</strong>g from their secret <strong>in</strong>volvement <strong>in</strong> LJM2. Thebanks were engag<strong>in</strong>g <strong>in</strong> other secret commercial transactions with Enron that were enrich<strong>in</strong>g thebanks <strong>and</strong> aga<strong>in</strong> boost<strong>in</strong>g Enron's reported pr<strong>of</strong>its while hid<strong>in</strong>g its debts. In each <strong>of</strong> these <strong>in</strong>stances,CIBC was mak<strong>in</strong>g huge returns on illicit transactions with Enron. And the longer Enron could bepropped up <strong>and</strong> the Ponzi scheme cont<strong>in</strong>ue, the longer CIBC could cont<strong>in</strong>ue <strong>to</strong> pocket these hugereturns from such 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., CIBC was extract<strong>in</strong>g from Enron by help<strong>in</strong>g <strong>to</strong> keep 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 for Enron or related entities; $870 million raised from the sale <strong>of</strong> commons<strong>to</strong>ck <strong>in</strong> 5/98; another $870 million raised via the sale <strong>of</strong> common s<strong>to</strong>ck <strong>in</strong> 2/99; $500 million <strong>in</strong>Enron 7.375% notes sold <strong>in</strong> 5/99; the $550 million New Power IPO <strong>in</strong> 10/00; <strong>and</strong> $1 billion <strong>in</strong>Marl<strong>in</strong> Water certificates <strong>in</strong> 7/01. While the <strong>in</strong>vestment bank<strong>in</strong>g fees <strong>to</strong> be ga<strong>in</strong>ed <strong>in</strong> an isolatedsecurities <strong>of</strong>fer<strong>in</strong>g by an <strong>in</strong>vestment bank which does not have an ongo<strong>in</strong>g relationship with theissuer may not, <strong>in</strong> <strong>and</strong> <strong>of</strong> itself, create sufficient weight <strong>to</strong> show a motive <strong>to</strong> defraud – surely the size- 120 -
<strong>and</strong> the cont<strong>in</strong>uity <strong>of</strong> the <strong>in</strong>vestment bank<strong>in</strong>g fees here, especially when comb<strong>in</strong>ed with the fees be<strong>in</strong>gobta<strong>in</strong>ed from the bank's commercial activities <strong>in</strong> the context <strong>of</strong> the bank's secret <strong>in</strong>volvement <strong>in</strong> theLJM2 partnership must be given great weight vis-à-vis motive. After all, a compla<strong>in</strong>t is <strong>to</strong> beconstrued <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.CIBC claims that it lost money at the end <strong>of</strong> the day when the Ponzi scheme collapsed. Thus,it says it would have been irrational for it <strong>to</strong> have engage <strong>in</strong> the Ponzi scheme. But if participation<strong>in</strong> a Ponzi scheme is always per se irrational why are there so many <strong>of</strong> them? But this argumentactually cuts aga<strong>in</strong>st CIBC. Like a gambler at the craps table who has a long run <strong>of</strong> good luck, butkeeps 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>allyrolls a seven, CIBC did very, very well for itself <strong>and</strong> its <strong>to</strong>p executives as long as the run <strong>of</strong> goodluck cont<strong>in</strong>ued, i.e., the Enron house <strong>of</strong> cards s<strong>to</strong>od. But, they paid the price when seven came up.In fact, as the f<strong>in</strong>ancial exposure <strong>of</strong> the banks <strong>to</strong> Enron <strong>in</strong>creased as the scheme progressed, it only<strong>in</strong>creased the motive <strong>of</strong> the banks, like CIBC, <strong>to</strong> keep Enron look<strong>in</strong>g good <strong>and</strong> keep its s<strong>to</strong>ck priceup so that its <strong>in</strong>creas<strong>in</strong>gly fragile f<strong>in</strong>ancial structure would not collapse <strong>and</strong> so that Enron wouldcont<strong>in</strong>ue <strong>to</strong> have access, with the help <strong>of</strong> the banks, <strong>to</strong> the capital markets <strong>to</strong> raise monies <strong>to</strong> payback Enron's debts <strong>to</strong> the bank.At the end <strong>of</strong> the day, the scienter allegations aga<strong>in</strong>st the banks <strong>in</strong> this CC, <strong>in</strong>clud<strong>in</strong>g CIBC,are uniquely strong <strong>in</strong> part because <strong>of</strong> the unique circumstances <strong>of</strong> this case. The banks named asdefendants here, <strong>in</strong>clud<strong>in</strong>g CIBC, 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> types <strong>of</strong> commercial transactions they engaged <strong>in</strong> with Enron. In so do<strong>in</strong>g, they entangledthemselves <strong>in</strong> the affairs <strong>of</strong> the company 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 United States. 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>g statements because it gave them – the banks <strong>and</strong> their <strong>to</strong>p executives– the opportunity <strong>to</strong> reap huge pr<strong>of</strong>its. Hav<strong>in</strong>g <strong>to</strong>p bank executives <strong>and</strong> banks secretly <strong>in</strong>vestmillions <strong>of</strong> dollars <strong>in</strong> partnerships that engage <strong>in</strong> non-arm's-length fraudulent transactions with apublic company <strong>to</strong> loot it, while creat<strong>in</strong>g hundreds <strong>of</strong> millions <strong>of</strong> dollars <strong>of</strong> phony pr<strong>of</strong>its <strong>and</strong> hid<strong>in</strong>gbillions <strong>of</strong> dollars <strong>of</strong> debt, while the banks were secretly engag<strong>in</strong>g <strong>in</strong> other bogus transactions withthe public company, further artificially boost<strong>in</strong>g its reported earn<strong>in</strong>gs <strong>and</strong> hid<strong>in</strong>g additional billions- 121 -
<strong>of</strong> dollars <strong>of</strong> debt <strong>and</strong> all the while issu<strong>in</strong>g glow<strong>in</strong>g analysts' reports prais<strong>in</strong>g the skill <strong>and</strong> <strong>in</strong>tegrity<strong>of</strong> the company's management, the tremendous successes <strong>of</strong> its core bus<strong>in</strong>esses, the success <strong>of</strong> its riskmanagement <strong>and</strong> hedg<strong>in</strong>g techniques, <strong>and</strong> its wonderful future bus<strong>in</strong>ess <strong>and</strong> earn<strong>in</strong>gs prospects, issimply not bank<strong>in</strong>g bus<strong>in</strong>ess as usual. Or if it is, this country <strong>and</strong> our f<strong>in</strong>ancial markets are <strong>in</strong> terribletrouble.VIII.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> The New York Times, 5/10/02"Andersen Lawyer Accuses Prosecu<strong>to</strong>rs <strong>of</strong> Misconduct":... [I]n one e-mail message written by Mr. Neuhausen [an Arthur Andersen partner]... he lambasted Enron's plan <strong>to</strong> allow its chief f<strong>in</strong>ancial <strong>of</strong>ficer <strong>to</strong> run a partnershipthat did bus<strong>in</strong>ess with the company, call<strong>in</strong>g it terrible <strong>and</strong> ask<strong>in</strong>g, "Why would anydirec<strong>to</strong>r sign <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:[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, JP Morgan <strong>and</strong> CIBC, werelured <strong>in</strong><strong>to</strong> the LJM2 partnership by the promise <strong>of</strong> potentially rich returns <strong>and</strong> thechance <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.- 122 -
* * *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.645. 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, JP 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).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> CIBC's culpability, which states a claim upon which relief can be granted underaccepted 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. BERNAYMATTHEW P. SIBEN/S/WILLIAM S. LERACHWILLIAM S. LERACH- 123 -
401 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. GREENBERGState Bar No. 08390000Federal I.D. No. 3932/S/ROGER B. GREENBERGROGER B. GREENBERGTwo Hous<strong>to</strong>n Center909 Fann<strong>in</strong>, Suite 2000Hous<strong>to</strong>n, TX 77010Telephone: 713/752-0017HOEFFNER BILEK & EIDMANTHOMAS E. BILEKFederal Bar No. 9338State Bar No. 02313525Lyric Office Centre440 Louisiana Street, 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: 212/759-4600- 124 -
SHAPIRO HABER & URMY LLPTHOMAS G. SHAPIRO75 State StreetBos<strong>to</strong>n, MA 02109Telephone: 617/439-3939At<strong>to</strong>rneys for van de VeldeTHE 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- 125 -