235 F. Supp. 2d 549 (S.D. Tex. 2002)
(9) Deutsche Bank AG's motion to dismiss (# 716) is GRANTED;
(10) Kirkland & Ellis's motion to dismiss (# 660) is GRANTED;
(11) Vinson & Elkins L.L.P.'s motion to dismiss (# 648) is DENIED; and
(12) Arthur Andersen LLP's motion to dismiss (# 650) is DENIED; and
(13) Lead Plaintiff's § 10(b) claims relating to the 7% Exchangeable Notes and 8.375% Notes are DISMISSED.
[1] "Each averment of a pleading shall be simple, concise, and direct."
[2] Rule 9(b) provides,
Fraud, Mistake, Condition of Mind In all averments of fraud, or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally.
In securities fraud actions, the Fifth Circuit applies and strictly interprets Rule 9(b) as requiring a plaintiff to "specify the statements contended to be fraudulent, identify the speaker, state when and where the statements were made, and explain why the statements were fraudulent." Abrams v. Baker Hughes, Inc., 292 F.3d 424, 430 (5th Cir.2002); Williams v. WMX Techs., Inc., 112 F.3d 175, 177 (5th Cir.) (citing Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir.1993)), cert. denied, 522 U.S. 966, 118 S.Ct. 412, 139 L.Ed.2d 315 (1997).
The Fifth Circuit treats a dismissal for failure to plead fraud with particularity under Rule 9(b) as a dismissal for failure to state a claim upon which relief can be granted under Rule 12(b)(6). Lovelace v. Software Spectrum, Inc., 78 F.3d 1015, 1017 (5th Cir.1996), citing Shushany v. Allwaste, Inc., 992 F.2d 517, 520 (5th Cir.1993).
[3] In reviewing the sufficiency of a complaint in response to a motion to dismiss for failure to state a claim under Fed.R.Civ.P. 12(b)(6), before any evidence has been submitted, the district court's task is limited. Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974). The issue is not whether a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support its claims. Id. The district court should consider all allegations in favor of the plaintiff and accept as true all well-pleaded facts in the complaint. Lawal v. British Airways, PLC, 812 F.Supp. 713, 716 (S.D.Tex. 1992). Dismissal is not appropriate "unless it appears beyond a doubt that the plaintiff can prove no set of facts in support of [his] claim which would entitle him to relief". Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957).
Nevertheless, conclusory allegations or legal conclusions masquerading as factual conclusions do not defeat a motion to dismiss. Fernandez-Montes v. Allied Pilots Assoc., 987 F.2d 278, 284 (5th Cir.1993). Courts need only accept well-pleaded factual allegations as true. Shushany v. Allwaste, Inc., 992 F.2d 517, 520, 523 (5th Cir.1993); Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1067 (5th Cir.1994) (courts should "not accept as true conclusory allegations or unwarranted deductions of fact.").
In the instant action, as discussed above and below, Plaintiff must also satisfy the pleading requirements of Rule 9(b)(fraud must be pled with particularity) and for scienter under the PSLRA and Rule 10b-5.
[4] Central Bank v. First Interstate Bank, 511 U.S. at 191, 114 S.Ct. 1439.
[5] Plaintiff's consolidated complaint asserts claims against various subsidiaries and affiliates of J.P. Morgan Chase & Co., which Plaintiffs refer to collectively as "JPMorgan Chase." J.P. Morgan Chase & Co. objects that these corporations are separate entities. J.P. Morgan Chase & Co. was formed on December 31, 2000 by the merger of J.P. Morgan & Co. Incorporated and The Chase Manhattan Corporation.
Although the consolidated complaint names Lehman Brothers Holdings Inc. as a defendant, Lehman Brothers asserts, and points to paragraph 108 in the complaint to show that Lead Plaintiff concedes that the banking and advisory services at issue are provided only by its subsidiary, Lehman Brothers Inc.
Similarly in its memorandum supporting its motion to dismiss (# 630 at 10 n. 3), Citigroup writes, "For purposes of this motion only, we accept as true plaintiff's allegation that the entity that did those things [alleged by plaintiff] was Citigroup, Inc. In fact, however, any business dealings with Enron were those of Citigroup's subsidiaries, including Citibank, N.A. and Salomon Smith Barney, Inc." Bank of America raises a similar challenge with respect to its subsidiary, Bank of America Securities LLC. # 665 at 1 n. 1 and 9-10.
These objections cannot be dealt with in the context of a motion to dismiss. Defendants who remain in this litigation may file an appropriate motion with a supporting brief and evidence challenging Plaintiff's one-entity approach, but for purposes of the motion to dismiss this Court will assume that Plaintiff's characterization is proper.
[6] Article 33(a) was based on § 12(a)(2) of the 1933 Act, 15 U.S.C. § 77l(a)(2), and like § 12(a)(2) is basically a strict liability statute (unless one of the express exceptions applies) with no scienter requirement. Texas Capital Securities, 58 S.W.3d at 775, citing Flowers, 472 S.W.2d at 115.
[7] This Court has found no cases addressing the effect of Central Bank v. First Interstate Bank, 511 U.S. 164, 191, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994) (holding that a "private plaintiff may not maintain an aiding and abetting suit under § 10(b).") on the Texas Securities Act. Because the Supreme Court relied on the language and legislative history of the federal 1934 Act, and because the Texas statute contains language expressly providing for aiding and abetting liability, this Court assumes the holding of Central Bank does not apply to the express provision for such secondary liability under article 581-33(F) in the Texas Securities Act.
[8] The United States Supreme Court has held that the term "manipulation" as used in § 10(b) is "`virtually a term of art when used in connection with securities markets'" and refers to practices "such as wash sales, matched orders, or rigged prices, that are intended to mislead investors by artificially affecting market activity." Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 476, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977), quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976) (Market "manipulation" "connotes intentional and willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities."). The Supreme Court explained,
"Wash sales" are transactions involving no change in beneficial ownership. "Matched" orders are orders for the purchase/sale of a security that are entered with the knowledge that orders of substantially the same size, at substantially the same time and price, have been or will be entered by the same or different persons for the sale/purchase of such security. Section 9(a) of the 1934 Act, 15 U.S.C. § 78i(a)(1), proscribes wash sales and matched orders when effectuated "(f)or the purpose of creating a false or misleading appearance of active trading in any security registered on a national securities exchange, or ... with respect to the market for any such security."
Ernst & Ernst, 425 U.S. at 205 n. 25, 96 S.Ct. 1375. "[T]he basic aim of the antifraud provisions is to `prevent rigging of the market and to permit operation of the natural law of supply and demand.'" SEC v. First Jersey, Inc., 101 F.3d 1450, 1466 (2d Cir.1996) (citing United States v. Stein, 456 F.2d 844, 850 (2d Cir.)), cert. denied, (408 U.S. 922, 92 S.Ct. 2489, 33 L.Ed.2d 333 (1972)), cert. denied, 522 U.S. 812, 118 S.Ct. 57, 139 L.Ed.2d 21 (1977). "The gravamen of manipulation is deception of investors into believing that prices at which they purchase and sell securities are determined by the natural interplay of supply and demand, not rigged by manipulators." Gurary v. Winehouse, 190 F.3d 37, 45 (2d Cir.1999).
[9] In Santa Fe the Supreme Court defined "deception" as used in § 10(b) as the making of a material misrepresentation or the nondisclosure of material information in violation of a duty to disclose. 430 U.S. at 470, 97 S.Ct. 1292. Thus the statute prohibits only the making of a material misstatement (or omission) or the commission of a manipulative or deceptive act. Because "manipulation" is essentially a limited term of art, the focus in most securities violations is on deception or misrepresentation. Santa Fe, 430 U.S. at 476, 97 S.Ct. 1292. Id. at 473, 97 S.Ct. 1292 (material misstatement (or omission)); at 475-77 (§ 10(b) must be, read flexibly, not technically and provides a cause of action for any Plaintiff who suffers an injury as a result of a deceptive practice touching its sale or purchase of a security. "No doubt Congress meant to prohibit the full range of ingenious devices that might be used to manipulate securities prices."). Nevertheless aiding and abetting liability is not covered by § 10(b). Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. at 177, 114 S.Ct. 1439 ("The [statute's] proscription does not include giving aid to a person who commits a manipulative or deceptive act.").
[10] In Ernst & Ernst, the Supreme Court turned to Webster's International Dictionary (2d ed.1934) for definitions of "device" and "contrivance" in concluding that "[t]he words manipulative or deceptive' used in conjunction with device or contrivance' strongly suggest that § 10(b) was intended to proscribe knowing or intentional conduct," and not merely negligence. 425 U.S. at 197, 199, 96 S.Ct. 1375. The dictionary defined "device' as (t)hat which is devised, or formed by design'; a contrivance; an invention; project; scheme; often a scheme to deceive; a stratagem; an artifice, and contrivance' in pertinent part as (a) thing contrived or used in contriving; a scheme, plan, or artifice.' In turn, contrive' in pertinent part is defined as (t)o devise; to plan, to plot ... (t)o fabricate ... design; invent ... to scheme.'" 425 U.S. at 199 n. 20, 96 S.Ct. 1375.
[11] GAAP, or Generally Accepted Accounting Principles, " are the official standards adopted by the American Institute of Certified Public Accountants (the "AICPA"), a private professional association, through three successor groups that it established, the Committee on Accounting Procedure, the Accounting Principles Board (the "APB"), and the Financial Accounting Standards Board (the "FASB").'" *In re K-tel Intern., Inc. Securities Litigation*, 300 F.3d 881, 889 (8th Cir.2002), quoting *Ganino v. Citizens Utils. Co.*, 228 F.3d 154, 160 n. 4 (2d Cir.2000). These rules apply to preparation of regular reports such as the 10-K and 10-Q form statements that publicly traded corporations must file annually or quarterly with the SEC. " There are 19 different GAAP sources, any number of which might present conflicting treatments of a particular accounting question.'" Id. at 889, quoting Shalala v. Guernsey Mem'l Hosp., 514 U.S. 87, 101, 115 S.Ct. 1232, 131 L.Ed.2d 106 (1995). Thus GAAP " are far from being a canonical set of rules that will ensure identical accounting treatment of identical transactions. [GAAP], rather, tolerate a range of "reasonable" treatments, leaving the choice among alternatives to management.'" *Id.*, quoting *Thor Power Tool Co. v. C.I.R.*, 439 U.S. 522, 544, 99 S.Ct. 773, 58 L.Ed.2d 785 (1979). "When ... conflicts arise, the accountant is directed to consult an elaborate hierarchy of GAAP sources to determine which treatment to follow.'" Id. "`In the event there is no official pronouncement, the consensus of the accounting profession, as manifested in textbooks, for example, determines GAAP.'" Id., quoting Providence Hosp. of Toppenish v. Shalala, 52 F.3d 213, 218 n. 7 (9th Cir.1995).
[12] In accord on the proposition that allegations of GAAP violations, standing alone, are insufficient to raise an inference of scienter under the federal securities laws are DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 390 (9th Cir.2002); City of Philadelphia v. Fleming Cos., Inc., 264 F.3d 1245, 1261 (10th Cir.2001) ("Only where such allegations [of violations of GAAP] are coupled with evidence that the violations or irregularities were the result of the defendant's fraudulent intent to mislead investors may they be sufficient to state a claim."); Ziemba v. Cascade Int'l, Inc., 256 F.3d 1194, 1208 (11th Cir.2001); In re K-tel Intern'l, Inc. Securities Litigation, 300 F.3d 881; Chill v. Gen. Elec. Co., 101 F.3d 263, 270 (2d Cir.1996) ("Allegations of a violation of GAAP provisions or SEC regulations, without corresponding fraudulent intent, are not sufficient to state a securities fraud claim").
[13] In Nathenson, the Fifth Circuit quotes the following passage from Abell v. Potomac Ins. Co., 858 F.2d 1104, 1117-18 (5th Cir.1988), vacated on other grounds sub nom. Fryar v. Abell, 492 U.S. 914, 109 S.Ct. 3236, 106 L.Ed.2d 584 (1989), to explain the meaning of reliance for purposes of § 10(b) and Rule 10b-5:
The element of reliance is the subjective counterpart to the objective element of materiality. Whereas materiality requires the plaintiff to demonstrate how a "reasonable" investor would have viewed the defendants' statements and omissions, reliance requires a plaintiff to prove that it actually based its decisions upon the defendants' misstatements or omissions. "Reliance is causa sine qua non, a type of `but for' requirement: had the investor known the truth he would not have acted." ... Thus, [c]ourts sometimes consider the reliance component of the Rule 10b-5 action to be a part of the causation element. In this context, the term "transaction causation" is used to describe the requirement that the defendant's fraud must precipitate the investment decision.... On the other hand, "loss causation" refers to a direct causal link between the misstatement and the claimant's economic loss. [citations omitted]
267 F.3d at 413.
[14] Corporate insiders do not have a duty to disclose all material information to the public; but rather their duty is either to disclose the confidential information which is the basis for their wanting to sell their stock or to abstain from trading until such disclosure is made. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir.1968)(en banc), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969); Chiarella, 445 U.S. at 228, 100 S.Ct. 1108.
[15] Lead Plaintiff has alleged a scheme or course of business in which the various participant Defendants concealed a pattern of creating unlawful SPEs and utilizing fraudulent transactions with these entities as contrivances or deceptive devices to defraud investors into continuing to pour investment money into Enron securities to keep afloat the Ponzi scheme and thereby enrich themselves in a variety of ways. The Court finds that the purchase of Enron securities by misled investors was allegedly an integral part of the alleged scheme and necessary to further that scheme.
[16] 15 U.S.C. § 78j.
[17] Common to claims of deceptive statements about the financial condition of an issuing corporation and to claims based on market manipulation through deceptive trading activity is the introduction of inaccurate information into the marketplace. GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189, 205 (3d Cir.2001), cert. denied, ___ U.S. ___, 122 S.Ct. 2588, 153 L.Ed.2d 778 (2002).
[18] Although criminal violations of § 10(b) require a showing that the act was done willfully, the elements of a civil and criminal violations of the statute are otherwise the same, and courts in criminal cases frequently cite civil interpretations of the statute to determine whether there has been a violation.
[19] Bear Stearns & Co. is a clearing broker for different brokerage houses.
[20] In Blech II, the complaint alleged that Bear Stearns "acted as a direct participant in the alleged manipulative scheme"; that Bear Stearns "knew that the market prices of Blech Securities had to be maintained at artificially inflated levels in order for Blech to liquidate sufficient amounts of those securities to eliminate the debit balance outstanding at Bear Stearns and thereby eliminate Bear Stearns' own exposure to the risk of incurring losses"; that Bear Stearns had access to insider information about Blech's "financial condition, liquidity and net capital position"; that Blech had pledged its securities as collateral to lending banks and if the price declined, the banks would seize that collateral and sell it, thus lowering the market price; that if the stock went down, so would Blech's ability to borrow from the banks and it would be unable to meet margin calls on its own securities accounts, including accounts at Bear Stearns; that Bear Stearns had the "power to extend or deny credit to Blech ... based on the value of Blech securities held as collateral" and "the power and control to determine whether or not to execute securities transactions on behalf of Blech & Co. and its clients,"; and that Bear Stearns insisted that Blech sell the securities to reduce the debt that Blech owed to Bear Stearns and to eliminate Bear Stearns' exposure. 961 F.Supp. at 577-78. Judge Sweet, in denying Bear Stearns' motion to dismiss, found that the alleged "pressure exerted by Bear Stearns on Blech to reduce his debit balance, when combined with Bear Sterns' knowledge of Blech's sham trading and its clearing of such trades, does not `reflect ... the standard of [a] clearing broker.'" Id. at 585.
[21] This Court, under the Fifth Circuit, applies a different standard for pleading scienter than the Second Circuit, which regularly allows pleading motive and opportunity by themselves to suffice.
[22] From 1966 until 1994, private party suits against secondary actors for aiding and abetting primary violators of Section 10(b) had been allowed to proceed in federal court.
[23] In contrast, in 1995 the PSLRA authorized the SEC to bring enforcement actions against those who "knowingly provide[] substantial assistance to another person" in violation of the federal securities laws, but did not create a parallel private cause of action. 15 U.S.C. § 78t(f).
[24] In Klein v. Boyd, a panel of the Third Circuit Court of Appeals found that the law firm in the dispute could be liable as a primary violator of securities fraud even though the attorney did not sign the documents and was never known to the investor as a participant in the documents' creation. The appellate court concluded that once the law firm "elected to speak" by creating or participating in the creation of the documents it could not make material misrepresentations or omit material facts in drafting non-confidential documents such as opinion letters. Fed. Sec. L. Rep. (CCH) ¶ 90,136, 90,323 (3d Cir.1998)(citing and quoting from its earlier opinion, Kline v. First W. Gov't Sec., Inc., 24 F.3d 480, 490-91 (3rd Cir.1994)). The law firm's duty did "not arise from a fiduciary duty to the investors; rather, the duty arose when the law firm undertook the affirmative act of communicating with investors...." Id. at 90,323-24. Thus the court concluded that although the firm may not have a duty to blow the whistle on its client, once it chooses to speak, a law firm does have a duty to speak truthfully, to make accurate or correct material statements, even though the document may not be facially attributed to the lawyer. Id. at 90,325. The panel did require that the lawyer's "participation in the statement containing a misrepresentation or omission of a material fact [be] sufficiently significant that the statement can properly be attributed to the person as its author or co-author," so that it would not fall within the parameter of conduct constituting aiding and abetting. Id. In sum, the Third Circuit panel held that when a person participates in the creation of a statement for distribution to investors that is misleading due to a material misstatement or omission, but the person is not identified to the investors, the person may still be liable as a primary violator of section 10(b) and Rule 10b-5 so long as (1) the person knows (or is reckless in not knowing) that the statement will be relied upon by investors, (2) the person is aware (or is reckless in not being aware) of the material misstatement or omission, (3) the person played such a substantial role in the creation of the statement that the person could fairly be said to be the "author" or "co-author" of the statement, and the other requirements of primary liability are satisfied.
Id. at 90,325.
The SEC's brief, submitted in this action, was written for the en banc review in Klein, but the case settled before the entire court could examine the issue.
[25] As noted, § 10(b) uses the phrase "employs a manipulative device"; Rule 10b-5(b) uses the phrase, "makes a material misstatement (or omission)." As indicated in footnote 9 of this memorandum and order, the Supreme Court has interpreted "deception" as used in § 10(b) as meaning the making of a material misrepresentation or the nondisclosure of material information in violation of a duty to disclose, Santa Fe, 430 U.S. at 470, 97 S.Ct. 1292, and has thus concluded that the statute prohibits only the making of a material misstatement (or omission) or the commission of a manipulative act. Santa Fe, 430 U.S. at 473, 97 S.Ct. 1292 (holding that § 10(b) does not apply to breaches of fiduciary duty by majority shareholders against minority shareholders without an allegation of misrepresentation or lack of disclosure); Central Bank, 511 U.S. 164, 177, 114 S.Ct. 1439 (1994) ("The proscription does not include giving aid to a person who commits a manipulative or deceptive act.").
[26] The requirement that the secondary party, itself, allegedly make a misleading or false representation (or omission) or commit a deceptive act that violates § 10(b) brings the party within the primary liability definition of the statute and avoids aiding and abetting pitfalls of the too expansive "substantial participation" test.
[27] The Attorneys General of a number of states have also submitted an amicus curiae memorandum and agree (see instruments # 861 at 9-10 and # 876).
[28] Section 10(b) makes it "unlawful for any person ... [t]o use or employ, in connection with the purchase or sale of any security ..., any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe [emphasis added]." 15 U.S.C. § 78j.
[29] The Supreme Court stated in Mead, 533 U.S. at 229, 121 S.Ct. 2164,
This Court in Chevron recognized that Congress not only engages in express delegation of specific interpretive authority, but that [s]ometimes the legislative delegation to an agency on a particular question is implicit.... Congress, that is, may not have expressly delegated authority or responsibility to implement a particular provision or fill a particular gap. Yet it can still be apparent from the agency's generally conferred authority and other statutory circumstances that Congress would expect the agency be able to speak with the force of law when it addresses ambiguity in the statute or fills a space in the enacted law, even one about which "Congress did not have an intent" as to a particular result.... When circumstances implying such an expectation exist, a reviewing court has no business rejecting an agency's exercise of its generally conferred authority to resolve a particular statutory ambiguity simply because the agency's chosen resolution seems unwise, ... but is obliged to accept the agency's position if Congress has not previously spoken to the point at issue and the agency's interpretation is reasonable [citations omitted]....
[30] Congress passed the post-depression era securities fraud laws to achieve "broad remedial goals." Pinter v. Dahl, 486 U.S. 622, 653, 108 S.Ct. 2063, 100 L.Ed.2d 658 (1988). The Supreme Court identified these goals in Basic, 485 U.S. at 230, 108 S.Ct. 978:
The 1934 Act was designed to protect investors against manipulation of stock prices. See S.Rep. No. 792, 73d Cong., 2d Sess., 1-5 (1934). Underlying the adoption of extensive disclosure requirements was a legislative philosophy: "There cannot be honest markets without honest publicity. Manipulation and dishonest practices of the market place thrive upon mystery and secrecy." H.R.Rep. No. 1383, 73d Cong., 2d Sess., 11 (1934). This Court "repeatedly has described the
fundamental purpose' of the Act as implementing aphilosophy' of full disclosure.'" Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 477-78, 97 S.Ct. 1292, 51 L.Ed.2d 480 ... (1977), quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186, 84 S.Ct. 275, 11 L.Ed.2d 237 ... (1963).
[31] The Attorneys General of the States of Arkansas, California, Connecticut, Georgia, Illinois, Louisiana, Massachusetts, Montana, Nebraska, New Jersey, New Mexico, New York, Ohio, Oregon, Pennsylvania, Tennessee, Texas, Washington, West Virginia, and Wisconsin have filed an amicus curiae memorandum (# 861), joined by the Attorneys General of Indiana, Kentucky, Louisiana, Maryland, Michigan, Nevada, Oklahoma, and the Commonwealth of Puerto Rico (# 876). The Attorneys General also argue that Defendants have ignored the "scheme" or "course of business" liability or erroneously assumed that subsections (a) and (c) were impliedly struck down in Central Bank merely because it addressed only subsection (b) misrepresentation and omission and only secondary (aiding and abetting) liability. They point to the Supreme Court's subsequent opinion in Zandford, upholding scheme and course-of-business liability, as indicating that liability under subsections (a) and (c) remains intact. Construing Rule 10b-5 flexibly with a view to Congressional intent behind § 10(b) and noting that Rule 10b-5 was issued by the SEC in 1942 pursuant to § 10(b)'s authorization that the SEC define "manipulative or deceptive devices" or "contrivances" through rules and regulations, the Attorneys General argue, and the Court agrees, that the express language of the Rule's subdivisions, (a)(scheme liability),(b) (misrepresentation or omission liability), and (c)(course of business liability), establishes eight different types of manipulative or deceptive devices or contrivances that Defendants can commit and for which they can be held primarily liable:
Employing a device to defraud (Rule 10b-5(a));
Employing a scheme to defraud (Rule 10b-5(a));
Employing an artifice to defraud (Rule 10b-5(a));
Making any untrue statement of material fact (Rule 10b-5(b));
Omitting to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading (Rule 10b-5(b));
Engaging in an act which operates or would operate as a fraud or deceit upon anyone (Rule 10b-5(c));
Engaging in a practice which operates or would operate as a fraud or deceit upon anyone (Rule 10b-5(c));
Engaging in a course of business which operates or would operate as a fraud or deceit upon anyone (Rule 10b-5(c)).
Amicus Curiae Memorandum (# 876) at 4. Thus the Attorneys General concur with this Court, contrary to the arguments of some Defendants, that liability is not limited to the making of a material misstatement or omission, nor to a few very technical forms of manipulation. See, e.g., Santa Fe, 430 U.S. at 477, 97 S.Ct. 1292 ("No doubt Congress meant to prohibit the full range of ingenious devices that might be used to manipulate securities prices"); Herman & MacLean, 459 U.S. at 386, 103 S.Ct. 683 ("In furtherance of its objective, § 10(b) makes it unlawful to use any manipulative or deceptive device or contrivance' in connection with the purchase or sale of any security [emphasis in original]"); *Superintendent of Insurance v. Bankers Life and Casualty Co.*, 404 U.S. 6, 11 n. 7, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971) ("10(b) and Rule 10b-5 prohibit all fraudulent schemes in connection with the purchase or sale of securities whether the artifices employed involved a garden type variety of fraud, or present a unique form of deception [emphasis in original]." [citation omitted]); Cooper v. Pickett, 137 F.3d 616, 624 (9th Cir.1997) (Central Bank "does not preclude liability based on allegations that a group of defendants acted together to violate the securities laws, as long as each defendant committed a manipulative or deceptive act in furtherance of the scheme"); ZZZZ Best, 864 F.Supp. at 971 ("It appears that the scope of deceptive devices or schemes prohibited by subsections (a) and (c) is quite extensive")(rejecting dismissal of plaintiffs' allegations that Ernst & Young was primarily liable for its participation in creating publicly released statements, issuing a review report, and failing to disclose additional material facts because the allegations taken as a whole might make it liable under a scheme to defraud).
This Court does disagree with the Attorneys General where they step over the line to conspiracy and argue that participants in a scheme to defraud, no matter how small, are liable for other participants' conduct in furtherance of the scheme even if the participants did not commit a key act that itself violated § 10(b) and Rule 10b-5. The Court also differs with respect to Lead Plaintiff's analogy of liability under the securities statutes to that for criminal liability under wire fraud or mail fraud statutes in contending that a participant is liable for the conduct of all other participants in the scheme.
The Court observes that in Central Bank, in rejecting the argument that the statue's language, "directly or indirectly," shows that the Congress intended to reach everyone who engages even indirectly in the proscribed activities, the Supreme Court noted that "the problem is that aiding and abetting liability extends beyond persons who engage even indirectly, in a proscribed activity; aiding and abetting liability reaches persons who do not engage in the proscribed activities at all, but who give a degree of aid to those who do." 511 U.S. at 176, 114 S.Ct. 1439. "Aiding and abetting is `a method by which courts create secondary liability' in persons other than the violator of the statute." Id. at 184, 114 S.Ct. 1439 (quoting Pinter v. Dahl, 486 U.S. 622, 648 n. 24, 108 S.Ct. 2063, 100 L.Ed.2d 658 (1988)). The Supreme Court commented that Congress "knew how to impose aiding and abetting liability when it chose to do so, did so in the general criminal statute" in 1995. Id. at 176, 114 S.Ct. 1439. Nevertheless Congress did not provide for private aiding and abetting liability in any of the causes of action in the securities statutes nor has it passed a general civil aiding and abetting statute, but has specified, when it desires to impose such liability, such liability in selected, individual statutes. Id. at 179, 182-83, 114 S.Ct. 1439. In 1995 in the PSLRA, Congress expressly gave only the SEC the right to pursue enforcement actions against aiders and abettors in securities actions, but did not proffer that right to plaintiffs in private civil actions. Id. at 183, 114 S.Ct. 1439; 15 U.S.C. § 78t(f).
As will be further discussed, § 10(b) is silent about conspiracy liability and the securities statutes do not contain any provision authorizing a private cause of action for conspiratorial conduct. Dinsmore v. Squadron, Ellenoff, Plesent, Sheinfeld & Sorkin, 135 F.3d 837, 840-43 (2d Cir.1998) (holding "that where the requirements for primary liability [under § 10(b)] are not independently met, they may not be satisfied solely on one's participation in a conspiracy in which other parties have committed a primary violation"); In re Syntex Corp. Sec. Litig., 855 F.Supp. 1086, 1098 (N.D.Cal.1994), aff'd, 95 F.3d 922 (9th Cir.1996).
[32] The Dinsmore panel, 135 F.3d at 841, noted that the dissent in Central Bank recognized that the majority opinion barred conspiracy as the basis for a securities violation claim: "The Court's rationale would sweep away the decisions recognizing that a defendant may be found liable in a private action for conspiring to violate § 10(b) and Rule 10b-5." Central Bank, 114 S.Ct. at 1460 n. 12 (Stevens, J., dissenting).
[33] In the September 8, 2002 edition of The New York Times, which extensively discussed the broad effects of the terrorist attacks on the World Trade Center, including on the stock market, Gretchen Morgenson commented,
But perhaps a more significant lesson learned by investors is that, fearful though we all are of future attacks, a far greater risk to our continued prosperity and economic strength comes from within our shores, not without. The risk emanates from people in positions of power at corporations who cheat their shareholders, lie to investors and make millions in outsized compensation or well timed stock sales just before their games are exposed.
Gretchen Morgenson, "Market Watch: Rebound From Ruin, if Not From Distrust," Section 3 (Money and Business) at 1, The New York Times, (Sept. 8, 2002). The author included in her indictment "the huge financial institutions ... that appear to have helped companies hide their true financial positions from investors, earning handsome fees for their efforts." Id.
[34] Although inapplicable to the entities whose motions to dismiss are under review in this memorandum and order, because the Court will be addressing the issue of insider trading in motions filed by individual defendants, it includes relevant law under § 20A of the 1934 Act.
Section 20A of the Exchange Act, as amended, 15 U.S.C. § 78t-1(a), provides a private cause of action against a corporate insider for insider trading based on contemporaneous trading:
Any person who violates any provision of this chapter or the rules or regulations thereunder by purchasing or selling a security while in the possession of material, nonpublic information shall be liable .... to any person who, contemporaneously with the purchase or sale of securities that is the subject of such violation, has purchased (where such violation is based on a sale of securities) or sold (where such violation is based on a purchase of securities) securities of the same class.
Thus to have standing to sue under § 20A, a private plaintiff "must have purchased ... or sold ... securities of the same class' contemporaneously' with the insider transaction at issue." Clay v. Intern. Corp., 157 F.3d 1259, 1263 n. 5 (11th Cir.1998), vacated in part on other grounds, 176 F.3d 1381 (11th Cir.1999). As with control person liability under § 20(a) of the 1934 Act, liability under § 20A is derivative and requires proof of a separate underlying violation of the Act, such as a violation of § 10(b) and Rule 10b-5. In re Advanta Corp. Sec. Litig., 180 F.3d 525, 541 (3d Cir. 1999); Jackson National Ins. Co. v. Merrill Lynch & Co., Inc., 32 F.3d 697, 703 (2d Cir.1994) (reference to "this chapter" means that a plaintiff must plead a predicate violation of the 1934 Act or of rules and regulations promulgated thereunder); In re VeriFone Sec. Litig., 11 F.3d 865, 872 (9th Cir. 1993).
[35] In Melder, the Fifth Circuit concluded that Rule 9(b) applied to the plaintiffs' 1933 Securities Act claims because their complaint adopted wholesale all their allegations under the securities fraud claims for purposes of their 1933 Securities Act claims.
[36] Lead Plaintiff has made such disclaimers in the consolidated complaint regarding its § 11 claims.
[37] Economic harm is not identified as a basis for the exception.
[38] The Terminology section defines "knows" as "actual knowledge of the fact in question" and states that a "person's knowledge may be inferred from circumstances."
[39] Rather than focusing on Abell's decision to follow the traditional privity rule for malpractice claims, Trust Company instead cites Abell for the proposition, "In order for an attorney to have a legal duty to supply correct information that he is liable to a non-client for malpractice, the plaintiff must show that the attorney provided legal services and that the attorney knew that the third party intended to rely upon those legal services." 104 F.3d at 1487, citing Abell, 858 F.2d at 1133. In Trust Company, the Court found the attorney liable for negligent misrepresentation under Louisiana law, based on a duty to a third party "that flows from the codal provision that establishes liability for a stipulation pour autrui," or third party beneficiary. Having found that duty, the panel then determined that the plaintiff had satisfied all the elements for imposition of liability against the lawyer and his firm under Rule 10b-5.
[40] See also Anixter, 77 F.3d at 1226-27 n. 12 (even where there is no fiduciary or other relationship of trust and confidence with non-clients, accountants may still have a "special duty to disclose when they make affirmative statements on which they know the investors will rely").
[41] The Sixth Circuit's interpretation of "direct contacts" is broad. In SEC v. Washington County Utility District, 676 F.2d 218, 223 (6th Cir.1982), it explained,
A duty to disclose naturally devolved on those who had direct contacts with the `other side.' Direct contacts require neither physical presence nor face to face conversation. A person undertaking to furnish information which is misleading because of a failure to disclose material facts is a primary participant.
While SEC v. Washington County dealt with aiding and abetting claims before Central Bank was issued, Rubin, applying the same test, applies it to a primary Rule 10b-5 violator.
[42] In Ackerman, 106 bilked investors in a fraudulent tax shelter, as third parties, sued an attorney, Howard Schwarz, and his law firm for securities violations on the grounds that he wrote an opinion letter for the promoters representing that the venture was legitimate and stating that investors could rely on the credits and reductions that the promoters of the tax shelter were touting to sell the securities. The promoters subsequently absconded with the money and the IRS disavowed the deductions and credits and imposed interest and penalties on the investors. Schwarz argued that his duty ran only to the promoters to whom the opinion letter was addressed, and because the promoters knew the truth, the opinion letter's misrepresentations could not deceive them. Disagreeing, Judge Easterbrook wrote for the panel that Schwartz had consented to the distribution of his letter to accountants, attorneys, and tax advisors, who were agents of the investors, and that "[t]o give information to an agent is to give it to the principal ... so that it will affect the choice of investment." 947 F.2d at 847. Emphasizing that the case dealt with fraud, not negligence, the court concluded that Schwarz had acted recklessly, constituting the scienter for fraud, and that once he spoke and permitted the promoters to release his letter, he had a duty to tell the truth about material issues under Basic, 485 U.S. at 232-36, 108 S.Ct. 978. 947 F.2d at 847-48.
[43] "An unqualified' or clean audit is the highest level of assurance that an auditor can give an organization's financial statements. Accountants will qualify' their opinion where discrepancies are identified in a client's financial statements." In re Ikon Office Solutions, Inc., 277 F.3d 658, 663 n. 4 (3d Cir.2002).
[44] Ernst & Young was the successor-in-interest to the actual auditing firm, Arthur Young & Co. 51 S.W.3d at 574 n. 1.
[45] The final version of the part cited by the Texas Supreme Court in McCamish, and employing the same language as the draft, is Section 51, subsection 2 of the Restatement of Law Third-The Law Governing Lawyers (2000).
[46] A number of other states have applied Section 552 to make attorneys liable to nonclients for negligent misrepresentation. See Mehaffy, Rider, Windholz & Wilson v. Central Bank Denver, N.A., 892 P.2d 230, 236-37 (Colo. 1995) (based on attorney's opinion letter that the suit against his client had no merit); Petrillo v. Bachenberg, 139 N.J. 472, 655 A.2d 1354, 1360 (1995) ("a lawyer's duty may run to third parties who foreseeably rely on the lawyer's opinion or other legal services"); Hines v. Data Line Sys., Inc., 114 Wash.2d 127, 787 P.2d 8, 21 (1990); Garcia v. Rodey, Dickason, Sloan, Akin & Robb, P.A., 106 N.M. 757, 750 P.2d 118, 122-23 (1988); Collins v. Binkley, 750 S.W.2d 737 (Tenn.1988); Stinson v. Brand, 738 S.W.2d 186, 190 (Tenn. 1987). Federal courts, applying state law, have done the same. See, e.g., Greycas, Inc. v. Proud, 826 F.2d 1560, 1564-65 (7th Cir.1987) (applying Illinois law and concluding that an attorney owed a lender a duty to reveal the borrower's true financial status), cert. denied, 484 U.S. 1043, 108 S.Ct. 775, 98 L.Ed.2d 862 (1988); Menuskin v. Williams, 145 F.3d 755, 760 (6th Cir.1998) (applying Tennessee law and holding that the attorney of a title insurance company who prepared warranty deeds on property bought by the plaintiff, stating that the property was free of all liens and encumbrances, might be liable if the plaintiff reasonably relied on the warranty deeds in making the purchase).
[47] The Court is aware that the Fifth Circuit, in discussing what it surmised would be Texas' application of § 552 to accountants, reviewed three basic approaches to determining the scope of accountant liability for negligent representations to third parties that use and rely on the accountant's audit: (1) privity (the most restrictive); (2) foreseeability (the most expansive); and (3) the Restatement (Second) of Torts § 552, which falls in between, has been adopted by the majority of states, and is found by many courts "to be the most consistent with the policy foundations underlying the tort of negligent misrepresentation." Scottish Heritable Trust, PLC v. Peat Marwick Main & Co., 81 F.3d 606, 611-14 (5th Cir. 1996), cert. denied, 519 U.S. 869, 117 S.Ct. 182, 136 L.Ed.2d 121 (1996). In its analysis the Fifth Circuit observed that § 552's limitation of standing "to a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it" has been held by a number of jurisdictions to not include all potential investors because that "would render the requirement meaningless." Id. at 613. The appellate court feared that "[t]o predicate an accountants' duty to third parties on such things as the general knowledge that accountants possess about typical investors or tenuous inferences concerning future events would be to eviscerate the Restatement rule in favor of a de facto foreseeability approach — an approach which the Texas courts have refused to embrace." Id. at 614. It concluded after examining dicta in several Texas cases that "the Texas Supreme Court is unlikely to adopt a rule so universally avoided by sister states." Nevertheless the Fifth Circuit qualified that comment in a subsequent statement that "we conclude that such a potential investor is generally not within a limited group' under Texas law [emphasis added by this Court]." *Id.* at 613, 614. In reaching its view of how Texas might apply § 552 to accountants, the panel merely relied on dicta in *Cook Consultants v. Larson*, 700 S.W.2d 231, 236 (Tex.App.-Dallas 1985, writ ref'd n.r.e.)(observing that the defendant was a surveyor "[u]nlike, for example, future purchasers of shares of stock attempting to hold an accountant liable, Larson is not a member of an unlimited class...."); *Blue Bell, Inc. v. Peat, Marwick, Mitchell & Co.*, 715 S.W.2d 408, 411 (Tex.App.-Dallas 1986, writ ref'd) (holding that "actual knowledge of a particular plaintiff is not necessary if the defendant should have had this knowledge" and that "when the auditors supplied the corporation with a number of audit reports, indicating knowledge by the auditors that third parties would be given these reports, one of a limited number of existing [as opposed to potential] trade creditors' was in a `limited group' under Texas law.") 81 F.3d at 614. Nevertheless, the Fifth Circuit did state, "[W]e do not suggest that a potential purchaser can never be a member of a limited group." Id. at 614.
This Court finds that the facts in Scottish Heritable and the Texas cases it discusses are easily distinguishable from those alleged here, in many ways that are not necessary to explain. The key factor is that in Newby, Lead Plaintiff has alleged that a vital part of the Ponzi scheme was to draw in continually more and more investors' funds through the continued sale of Enron securities so that Enron could expand its operations (an expensive proposition given the allegations that the sham transactions it engaged in through the SPEs were financial "losers" and the SPEs served to conceal Enron's ever-increasing debt) and to pay down its existing debt, including to the bank Defendants participating with Enron in the scheme. Thus the potential investors were allegedly the intended targets of the reports and documents drafted and issued by Arthur Andersen and Vinson & Elkins, whether for Enron which they allegedly expected to use the misrepresentations to lure in more investment funds or for the public via SEC filings. As the Texas Supreme Court indicated in McCamish, the "limited group" restriction protects against unlimited liability: "[t]his formulation limits liability to situations in which the attorney who provides the information is aware of the nonclient and intends that the nonclient rely on the information." 991 S.W.2d at 793. That is the circumstance alleged in the consolidated complaint. Furthermore, in Pacific Mutual, although a fraudulent misrepresentation case, the plaintiff was an institutional investor that relied on audits subsequently included in statements and filings following a merger. The reason why the plaintiff lost was not that it was merely a potential investor, but because the statements it relied on were issued by a different entity than the one whose notes the plaintiff purchased and the prospectuses related to other securities issued later by the bank with which the first issuer merged.
[48] As one means of effectuating the alleged Ponzi scheme to defraud investors, a series of partnerships and SPEs clandestinely controlled by Enron were allegedly created, structured, financed and utilized by Defendants to inflate Enron's profits and conceal its debt. The complaint explains, "A public company that conducts business with an SPE may treat the SPE as if it were an independent entity only if it does not control the SPE. At a bare minimum, two conditions must be met: (i) an owner independent of the company must make an equity investment of at least 3% of the SPE's assets, and that 3% must remain at risk throughout the transaction; and (ii) the independent owner must exercise control of the SPE." Consolidated complaint at 15 (emphasis added by complaint).
[49] Lead Plaintiff points out that GAAP, Accounting Research Bulletin ("ARB") No. 51, states,
There is a presumption that consolidated statements are more meaningful than separate statements and that they are usually necessary for a fair presentation when one of the companies in the group directly or indirectly has a controlling financial interest in the other companies.
Consolidated complaint at 272. Moreover, FASB Statement of Financial Accounting Standards ("SFAS") No. 94 mandates consolidation of all majority-owned subsidiaries unless control is temporary or does not rest with the majority owner. Consolidated complaint at 273.
The complaint also quotes from FASB Emerging Issues Task Force Abstracts ("EITF"), Topic No. D-14, which provides guidance for non-consolidation of an SPE:
Generally, the SEC staff believes that for nonconsolidation and sales recognition by the sponsor or transferor to be appropriate, the majority owner (or owners) of the SPE must be an independent third party who has made a substantive capital investment in the SPE, has control of the SPE, and has substantive risks and rewards of ownership of the assets of the SPE (including residuals). Conversely, the SEC staff believes that nonconsolidation and sales recognition are not appropriate by the sponsor or transferor when the majority owner of the SPE makes only a nominal capital investment, the activities of the SPE are virtually all on the sponsor's or transferor's behalf, and the substantive risks and rewards of the assets or the debt of the SPE rest directly or indirectly with the sponsor or transferor. Consolidated complaint at 273 n. 7.
[50] Lead Plaintiff asserts that LJM1 was utilized to allow Enron to engage in phony hedging transactions largely dependent on the value of Enron's own stock. The consolidated complaint details Enron's use of LJM1 to hedge its position in Rhythms NetConnections ("Rhythms") (at pp. 280-82, 413). Briefly, in 1999, to hedge Enron's gains on the value of Rhythms' stock, Enron transferred Enron stock to Rhythms in exchange for a note. The hedge was a sham because if the SPE had to pay Enron on the "hedge," Enron stock would be the source of that payment. Enron recognized $100 million from the hedging transaction in 1999.
[51] As one reflection of their lack of independence, employees of both LJM partnerships allegedly were regular, full-time employees of Enron for benefits purposes. Consolidated complaint at 279.
[52] See consolidated complaint at 287-92 for specific allegations about the Raptors and their purposes.
[53] The consolidated complaint lists examples of manipulative transactions relating to unsuccessful assets acquired by Enron that were sold to, and thereby shifted losses to, LJM1 or LJM2 when a legitimate buyer could not be found because the assets for sale were unattractive. Lead Plaintiff briefly describes how each transaction was used to falsify Enron's financial results and financial condition. For instance, Enron shifted a 13% stake (sufficient to relieve it of "control" of that entity so that it did not have to consolidate its interest and report it on Enron's balance sheet) in a troubled power plant construction in Cuiaba, Brazil, to LJM1 for $11.3 billion in September 1999 so that Enron realized $34 million of mark-to-market income in the third quarter of 1999 and $31 million in the fourth quarter and another $41 million of mark-to-market income in the fourth quarter of 1999. (For an explanation of mark-to-market accounting, see pages 123-25 and nn. 58, 59 of this memorandum and order.) Then in August 2001 Enron repurchased LJM1's purchase for $14.4 million, giving LJM1 investors a tidy profit. Because Enron had always promised to make LJM1 whole, LJM1's investment in the Cuiaba power plant was never "at risk." Other examples included Enron North America ("ENA") collateralized loan obligations, the lowest rated of which were sold to Enron-controlled Whitewing Associates, LLP and to LJM2 with assurances from Enron that the investors would be made whole; the Nowa Sarzyna power plant under construction in Poland, which Enron temporarily "sold" to LJM2 for $30 million so that Enron could record a profit of $16 million, but then repurchased later for $31.9 million, giving LJM2 an approximately 25% rate of return; a 90% interest in MEGS LLC (a company owning a natural gas gathering system in the Gulf of Mexico), which Enron sold to and repurchased from LJM2 at the maximum allowed rate; certificates of a trust known as Yosemite, improperly sold to LJM2 on December 29, 1999 to hold for one day and then sold to Condor, allowing Enron to avoid reporting its interest in Yosemite in its year-end financial statement; and Backbone telecommunications assets, i.e., unactivated ("dark") fiber optic cable, sold to LJM2 in May 2000 so that Enron could meet its second quarter numbers. Consolidated complaint at 284-87.
[54] The Court notes that SEC Regulation S-X, 17 C.F.R. § 210.4-08(k)(1)(2001), requires identification of related party transactions and transaction amounts to be stated on the face of the balance sheet, income statement or statement of cash flows. William F. Dietrich, "Legal and Ethical Issues for attorneys dealing with Financial Data: Heightened Scrutiny After the Enron and Andersen Debacle," 1325 PLI/Corp 925, 947 and n. 57 (Aug.2002). While "related parties" include the parent company and its subsidiaries, an enterprise and its principal owners, management and members of their immediate families, and affiliates, the FASB's definition of "related parties" also reaches "other parties with which the enterprise may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests." Id. at 947 and nn. 58-60, citing FINANCIAL ACCOUNTING STANDARDS BOARD, Statement of Financial Accounting Standards No. 57: Related Party Disclosures, in 1 FINANCIAL ACCOUNTING STANDARDS BOARD, ORIGINAL PRONOUNCEMENTS: FASB STATEMENTS OF STANDARDS 1-100, at 556-57 (2001)("FAS 57"). There must also be disclosure of any control relationship when the reporting enterprise and another entity are under common ownership or management control that might affect the operating results or the financial status of the reporting enterprise, even if there are no transactions involved. Id. at 947-48, citing FAS 57 at ¶ 4 at 554.
[55] For instance, in its May 2000 proxy statement Enron described each LJM partnership as "a private investment company that primarily engages in acquiring or investing in energy and communications related to investments," a statement that would not disclose to the reader either the nature of the transactions or their import. A similar statement was made in the Form 10-Q for second quarter 1999, with a nonspecific footnote saying, "A senior officer of Enron is managing member of LJM's general partner." Virtually identical "disclosures" were made in the third quarter Form 10-Q and the 1999 10-K. In its Form 1-Q for the second quarter of 2000, Enron stated about the LJM partnerships, "In the first half of 2000, Enron entered into transactions with limited partnerships (the Related Party) whose general partner's managing member is a senior officer of Enron. The limited partners of the Related Party are unrelated to Enron." From that time on, Enron did not identify LJM1 or LJM2 by name in financial statement disclosures. Consolidated complaint at 297-98.
[56] The complaint identifies four examples. On December 22, 1999, Enron pooled purchaser collateralized loan rights ("CLOs") and sold the lowest-rated portion to an Enron Affiliate (Whitewing LLP) and LJM2. Whitewing in turn lent LJM2 the money to purchase Whitewing's interest in the CLOs. Enron surreptitiously guaranteed Whitewing's investment and its loan to LJM2. The deal allowed Enron to record a sale of millions of dollars in the fourth quarter of 1999 to an entity that was not independent and that should have been consolidated, with its debts listed on Enron's balance sheet.
Second, when it was unable to find an independent buyer before the end of 1999, Enron sold LJM2 a 75% interest in Nowa Sarzyna power plant for $30,000,000 (part loan, part equity). This transaction removed millions of dollars of debt from Enron's balance sheet and allowed Enron to record a gain of about $16 million from the sale. Although the debt financing required that Enron retain ownership of at least 47.5% of the equity until the project was completed, the lender waived this requirement until March 31, 2000, by which time Enron and Whitewing reacquired LJM2's equity interest and repaid the loan for a total of $31.9 million, providing LJM2 with a 25% rate of return.
Similarly, on December 29, 1999 Enron sold to LJM2 a 90% equity in MEGS LLC, a natural gas system in the Gulf of Mexico, thus avoiding consolidation and having to report millions of dollars in debt on Enron's balance sheet for that year. Enron also repurchased LJM2's interest in MEGS early the next year.
Finally, Enron made it appear that it sold certificates in a trust named Yosemite to LJM2 on December 29, 1999, to reduce Enron's interest in Yosemite from 50% to 10%, to avoid disclosing the certificates on Enron's 1999 financial statement. In actuality the transaction did not actually occur until February 28, 2000, but the legal documentation was clearly and deliberately back-dated to December 29, 1999. Meanwhile on December 29, 1999, Condor, which was an affiliate of Whitewing and was controlled by Enron, loaned $35 million to LJM2 so that it could buy the certificates. The next day, LJM2 transferred the certificates to Condor, satisfying the one-day loan.
[57] According to the complaint, in phony hedging arrangements in 2000-01 Enron funded the Raptors with its own stock, supposedly to hedge against declines in the value of Enron's merchant investments, but the "hedges" were actually manipulative or deceptive devices to circumvent accounting rules. Enron always retained most of the risk because it provided most of the capital with which the SPES would pay; if the value of Enron stock declined, the SPEs could not meet their obligations and the "hedges" would fail.
[58] The complaint recites, "A former employee noted, shifting the curve and making new deals to bury the losses from the past is constantly the strategy.' Another former trader stated: It was very simple. You just tweaked the assumptions on different variables, which were changed to make the return higher.'" Consolidated complaint at 305.
[59] The complaint states, "Because most DSM deals were losing money when their curves were re-marked, Enron had to keep signing new contracts each quarter to show a profit — what a DSM manager described as `feeding the beast.'" Complaint at 305-06. Recognizing earnings for long-term contracts in the quarter when the contract was signed forced Enron into increasingly aggressive and riskier deals, gave rise to enormous and growing accumulation of off-balance-sheet debt, contingent liabilities, and, by early in 2001, restricted opportunities to re-finance and restructure old deals, as well as to create new deals. Consolidated complaint at 306.
[60] The complaint at 465 quotes from U.S. News & World Report regarding Enron's aggressive abuse of mark-to-market accounting since the early 1990's:
... Traditional accounting would book revenue from a long-term contract when it came in. But Skilling wanted Enron to book all anticipated revenue immediately. The practice is known as mark-to-market — or more colloquially, counting your chickens before they hatch. Whatever the term, it was the third time in five years that Enron had significantly changed its accounting.
Tallying all expected profits immediately would mean a huge earning kick for a company obsessed with debt. But it would also put Enron on a treadmill: To keep growing, it would have to book bigger and bigger deals every quarter. The result, in hindsight, was predictable: a shift from Enron developing economically sound partnerships to doing deals at all costs. "The focus wasn't on maintaining relationships and serving customers," says a former Enron official. "The quality of the deals deteriorated." The turning point, some say, was a deal involving a British power facility that earned Enron brass big bonuses. Yet, says one executive, the deal was "a disaster" that forced Enron to cough up $400 million when gas prices moved the wrong way.
The new accounting made workers eligible for fatter payoffs. Enron employees were urged to work together on deals. But the new arrangements created an incentive to cut out colleagues, because bringing them in meant carving more slices in the bonus pie. "It was a very intense and urgent form of accounting," says Dan Riser, a former employee who worked with Skilling.
[61] As an example of such abuse in order to permit Enron to book improperly huge, illusory profits up front, the complaint at 306-07, describes a DSM with Eli Lilly. The complaint at 307 quotes from The Washington Post, 2/18/02:
Eli Lilly and Co., the Indianapolis pharmaceutical manufacturer, signed a $1.3 billion contract in February 2001 turning all its energy requirements over to Enron for 15 years. But Enron paid Eli Lilly $50 million upfront to win the deal, according to a former senior executive of Enron.
. . . . .
Such upfront payments were not unusual, said Glenn Dickson, a former EES director of asset operations. "It was fairly common on the really big deals to pay the customer to lose money, in effect, on the contract, whether you were paying the customer or losing the money you were charging less than it really cost."
What made it all work, Dickson said, was a form of accounting in which the company counted future projected earnings as current income. "It [w]as huge amounts of money that covered up those cash outlays."
The complaint also identifies companies which made deals with Enron to which Enron improperly applied mark-to-market accounting, including J.C. Penney, IBM, Owens Illinois, and Quaker Oats. Id. at 307, 310-11.
[62] Lead Plaintiff quotes several passages of a letter written to Enron's Board by an EES manager in August 2001:
One can only surmise that the removal of Jeff Skilling was an action taken by the board to correct the wrongdoings of the various management teams at Enron ... (i.e., EES's management's ... hiding losses/SEC violations).
... [I]t became obvious that EES had been doing deals for 2 years and was losing money on almost all deals they had booked. ... [I]t will add up to over $500MM that EES is losing and trying to hide in Wholesale. Rumor on the 7th floor is that it is closer to $1 Billion ... [T]hey decided ... to hide the $500MM in losses that EES was experiencing.... EES has knowingly misrepresented EES['s] earnings. This is common knowledge among all the EES employees, and is actually joked about. But it should be taken seriously.
[63] The complaint alleges that at the commencement of the deal, Enron created another partnership, EBS Content Systems LLC, or "Project Braveheart," again finagling to make it appear to be an independent entity when it was not and obtaining funding from CIBC with a guarantee from Enron, to improperly record $111 million in revenue from the sham Blockbuster deal. Consolidated complaint at 300-01. EBS then transferred its interest in the Blockbuster deal, fraudulently valued at $124.8 million, to Braveheart. No revenue should have been recorded from the Block-buster deal because (1) Braveheart was not independent of Enron; (2) EBS could not provide the service it promised and thus could not earn the projected revenue; (3) most of the projected customers did not yet exist and were unlikely to pay for the severely restricted services (40 movies loaded onto a Sun Server in four test cities) that were actually provided; and (4) the improper use of mark-to-market accounting resulted in sham estimates of future revenue streams. A former employee stated, "[T]he Blockbuster deal was a fraud, and Enron's top management knew it."
The complaint describes another misuse of mark-to-market accounting in a broadband deal involving Rice University. The deal, for $14 million over ten years, was that EBS would provide broadband to Breimen University in Germany, a sister university to Rice. Enron recognized all $14 million earnings up front by applying mark-to-market accounting during the second and third quarters of 2000. Furthermore, to secure the deal, Lay gave Rice a $5 million donation to build a wing. Under the deal Breimen could cancel at any time and did so in early 2001. Thus the revenue stream had not been earned and was not collectible at the time it was recognized. Consolidated complaint at 308.
[64] The complaint asserts that, as is typical of Enron's usual unfounded projections and manipulated calculations, in trying to decide how much it would cost to do VOD per subscriber, Enron developers "came up with a figure out of thin air-$1.20. There was no rational basis for this amount. However, it was used to calculate future profits to be derived from the project." Consolidated complaint at 301. In contrast, McKinsey Consulting told EBS that it would have to spend between $1,200-$1,600 per subscriber for equipment to get VOD to work.
[65] "Dark fiber" refers to fiber optic cables that have been laid, but are not yet in use, or "lit." Consolidated complaint at 302.
[66] The complaint asserts that Enron had a practice of engaging in swapping capacity of deliberately overvalued dark fiber and broadband trading with other telecom companies (including Dynegy, Williams, El Paso, Metromedia Fiber, Acrie Networks, Owest, Level 3, 360 Networks, and Touch America). Many of these swaps were effected to create the illusion of trading activity and to report sham income, thus manipulating Enron (and other entities') financial results. Most of the $120 million of revenue in 1999 that Enron reported for broadband was from such dark fiber swaps. Consolidated complaint at 302-03. In June 2000, for example, Enron sold dark fiber cable for $100 million to LJM2. LJM2 paid Enron $30 million in cash and gave Enron an interest-bearing note for $70 million, even though the dark fiber was not worth even close to that price. Enron recognized $67 million in pre-tax earnings that year from the asset sale. In the third quarter of 2000, a similar deal took place worth more than $300 million, so that Enron could "make its numbers," but that arrangement failed to follow protocol because network developers and traders were not informed about it until after it was accomplished. Complaint at 303. Sometimes the broadband traders traded among various Enron-controlled entities, breaking one transaction into a number of transactions, to create the impression of multiple and increasing numbers of deals.
[67] In a "true swap," according to the complaint,
two parties trade the future returns on investments over a set period of time. One party pays a small amount to receive a fixed interest rate on a corporate bond in lieu of uncertain gains on the same corporation's stock. The counterparty accepts the payment and swaps the return on the bond for the return on the stock. Neither party actually needs to hold the underlying assets as long as the payments are made. Typically, neither party in a true swap exchange receives all the agreed payments up front. In the Enron transactions, though, CitiGroup paid up front an estimate of the fair value of its portion of the swaps — hundreds of millions of dollars each time — payments made immediately. Enron was obliged to repay the cash over five years. These Delta transactions, though technically derivative trades known as prepaid swaps, perfectly replicated loans and were, in fact, manipulative devices to disguise what were, in reality, loans. Enron's balance sheet misrepresented these transactions. Enron posted the loans as "assets from price risk management" and as "accounts receivable," admitted Charlie Leonard, a spokesperson for Andersen. The repayments that Enron owed the banks were listed as "liabilities from price risk management" and possibly a small amount of accounts payable, Leonard said.
Consolidated complaint at 361.
[68] The complaint quotes The New York Times on February 17, 2002:
Technically, the transaction was a swap. But because CS First Boston paid Enron up front, the transaction took on the characteristics of a loan — a reality noted by the bank. "It was like a floating-rate loan," said Pam Pendleton, a CS First Boston spokesman. "We booked the transaction as a loan."
Complaint at 314.
[69] The complaint discusses similar loans disguised as transactions, e.g., at p. 315-16, with the Connecticut Resources Recovery Authority ("CRRA") and Connecticut Light and Power Company ("CL & P"), which involved a loan disguised as an energy contract for which revenue could be reported. In March 2001 the CL & P paid an Enron subsidiary $220 million, purportedly for the Enron entity to assume a contract to purchase the CRRA's trash-generated steam electricity, with the Enron subsidiary agreeing to repay CRRA in monthly installments nearly $2.4 million per month (constituting interest plus principal) until May 31, 2012, when the contract would expire. Enron never actually purchased the electricity; Enron entered into the transaction to obtain the immediate $220 million cash infusion, another deal in its regular practice of shoring up the company's precarious financial condition for the present through a deal that made no long-term financial sense.
[70] Enron International, a subsidiary of Enron, could properly recognize as revenue approximately 5% of a contract's value for construction services provided to Enron. Former employees, however, have reported that Enron International, in violation of GAAP, improperly recognized as revenue 10% of construction services contract values upon signing. Furthermore, it utilized a percentage of completion method of accounting, recognizing income as work progresses on the contract, for long-term construction contracts, a business practice which was false and misleading and resulted in an overstatement of revenues and earnings.
[71] In 1997 and 1998, according to the complaint, Enron regularly capitalized, rather than expensed, costs related to unsuccessful bids for projects and improperly included them in costs for future projects. The costs were finally written off in the first quarter of 1999, but to conceal the true nature of the writedown, the expenses were attributed to a "change in accounting." This practice of accumulating capital expenditures incurred on unsuccessful project proposals was known by accounting and finance personnel throughout Enron as "snowballing." The complaint alleges that the "snowball grew exponentially," to the point that an international accounting officer told Enron's CAO Richard Causey that Enron had to take a writedown because so many proposals were no longer even arguably viable. But Causey, directed by Jeffrey Skilling, responded that "corporate did not have room" to take a writedown because reducing the snowball would result in Enron's earnings going below expectations. By 1997, the snowball on about 75 projects in Central and South America and the Dabhol power plant in India was about $100 million and dwarfed revenue returns. When Enron recorded an after-tax charge of $131 million in the first quarter of 1999, it misled investors by making the accumulated writeoff costs (improperly recorded as assets rather than expenses on the balance sheet for years) appear to be the result of the initial adoption of two new accounting pronouncements, including Statement of Position 98-5, Reporting on the Costs of Start-up Activities, which requires that costs for all start-up activities and organization costs be expensed as they are incurred.
[72] The complaint maintains that SFAS No. 121 requires companies to review long-term assets to determine if they are impaired and in ¶ 5 identifies the following as circumstances requiring reassessment:
a. A significant decrease in the market value of an asset
b. A significant change in the extent or manner in which an asset is used or a significant physical change in an asset
c. A significant adverse change in legal factors or in the business climate that could affect the value of an asset or an adverse action or assessment by a regulator
d. An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset
e. A current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with an asset used for the purpose of producing revenue.
... 6. If the examples of events or changes in circumstances set forth in paragraph 5 are present or if other events or changes in circumstances indicate that the carrying amount of an asset that an entity expects to hold and use may not be recoverable, the entity shall estimate the future cash flows expected to result from the use of the asset and its eventual disposition. Future cash flows are future cash inflows expected to be generated by an asset less the future cash outflows expected to be necessary to obtain those inflows. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the entity shall recognize an impairment loss in accordance with this Statement. Otherwise, an impairment loss shall not be recognized; however, a review of depreciation policies may be appropriate.
SFAS No. 115 also requires that a loss be recorded for impairment in investments if the impairment is not temporary. Consolidated complaint at 319-20.
[73] The complaint quotes SEC Staff Accounting Bulletin No. 99, which, although issued in August 1999 after Enron and Arthur decided not to make the adjustments, states that it did not create new GAAP, but merely reemphasized existing GAAP:
Even though a misstatement of an individual amount may not cause the financial statements taken as a whole to be materially misstated, it may nonetheless, when aggregated with other misstatements, render the financial statements taken as a whole to be materially misleading. Registrants and the auditors of their financial statements accordingly should consider the effect of the misstatement on subtotals or totals. The auditor should aggregate all misstatements that affect each subtotal or total and consider whether the misstatements in the aggregate affect the subtotal or total in a way that causes the registrant's financial statements taken as a whole to be materially misleading.
[74] Under GAAP, SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, companies must record unrealized gains and losses on investments in securities that do not have readily determinable values as a separate component of stockholders' equity. Only unrealized holding gains and losses for trading securities, i.e., securities bought and held primarily to be sold in the near future, should be included in current earnings. SFAS No. 115 further provides that the fair value of an equity security is readily determinable if sales prices or bid-and-ask quotations are currently available on a securities exchange registered with the SEC or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated System or by the National Quotation Bureau. Restricted stock does not qualify. Complaint at 309-10.
The complaint, id., asserts that during the Class Period, Enron made false and misleading financial statements, first overvaluing holdings in various portfolio companies ("Merchant Assets"), and then misrepresenting that many had pretax gains of easily determinable values under the definition in SFAS No. 115, permitting Enron to record such unrealized gains as current income. They should have been reported as unrealized gains and losses and reported net of applicable income taxes in a separate component of stockholders' equity. For instance Enron recognized pretax gains from sales of merchant assets and investments by an Enron division known as Assets and Investments, which inter alia was involved with building power plants worldwide, operating them, selling off pieces of them and investing in debt and equity securities of energy- and technology-related business. The complaint states that Enron recognized pretax gains from sales of merchant assets and investments totaling $628 million in 1998 and $756 million in 1999 and claimed much of them had readily determinable value recordable as income. Id. at 309.
[75] Sherron Watkins wrote,
Skilling's abrupt departure will raise suspicions of accounting improprieties and valuation issues. Enron has been very aggressive in its accounting — most notably the Raptor transactions and the Condor vehicle. We do have valuation issues with our international assets and possibly some of our EES MTM positions.
The spotlight will be on us, the market just can't accept that Skilling is leaving his dream job.... How do we fix the Raptor and Condor deals? ... [W]e will have to pony up Enron stock and that won't go unnoticed.
We have recognized over $550 million of fair value gains on stock via our swaps with Raptor, much of that stock has declined significantly — Avici by 98% from $178 mm to $5 mm. The New Power Co. by 70%, from $20/share to $6/share. The value in the swaps won't be there for Raptor, so once again Enron will issue stock to offset these losses. Raptor is an LJM entity. It sure looks to the layman on the street that we are hiding losses in a related company and will compensate that company with Enron stock in the future.
I am incredibly nervous that we will implode in a wave of accounting scandals.... [T]he business world will consider the past successes as nothing but an elaborate accounting hoax....
[W]e booked the Condor and Raptor deals in 1999 and 2000, we enjoyed a wonderfully high stock price, many executives sold stock, we then try and reverse or fix the deals in 2001 and it's a bit like robbing the bank in one year and trying to pay it back 2 years later. Nice try, but investors were hurt, they bought at $70 and $80/share looking for $120/share and now they're at $38 or worse. We are under too much scrutiny and there are probably one or two disgruntled "redeployed" employees who know enough about "funny" accounting to get us in trouble.
I realize that we have a lot of smart people looking at this.... None of that will protect Enron if these transactions are ever disclosed in the bright light of day....
There is a veil of secrecy around LJM and Raptor. Employees question our accounting propriety consistently and constantly .... a. Jeff McMahon was highly vexed over the inherent conflicts of LJM. He complained mightily to Jeff Skilling .... 3 days later, Skilling offered him the CEO spot at Enron Industrial Markets....
b. Cliff Baxter complained mightily to Skilling and all who would listen about the inappropriateness of our transactions with LJM.
c. I have heard one manager level employee ... say " I know it would be devastating to all of us, but I wish we would get caught. We're such a crooked company." ...
Many similar comments are made when you ask about these deals.
A second Enron employee wrote the following statements:
One can only surmise that the removal of Jeff Skilling was an action taken by the board to correct the wrong doings of the various management teams at Enron. However ... I'm sure the board has only scratched the surface of the impending problems that plague Enron at the moment. ( i.e., EES's ... hiding losses/SEC violations ... lack of product, etc.)
The footnotes have been integrated via reference markers above for consistency with the original judicial formatting. All substantive citations, quotations, and holdings from the provided text are preserved verbatim.
virtually a term of art when used in connection with securities markets'" and refers to practices "such as wash sales, matched orders, or rigged prices, that are intended to mislead investors by artificially affecting market activity." *Santa Fe Indus., Inc. v. Green*, 430 U.S. 462, 476, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977), quoting *Ernst & Ernst v. Hochfelder*, 425 U.S. 185, 199, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976) (Market "manipulation" "connotes intentional and willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities."). The Supreme Court explained, "Wash sales" are transactions involving no change in beneficial ownership. "Matched" orders are orders for the purchase/sale of a security that are entered with the knowledge that orders of substantially the same size, at substantially the same time and price, have been or will be entered by the same or different persons for the sale/purchase of such security. Section 9(a) of the 1934 Act, 15 U.S.C. § 78i(a)(1), proscribes wash sales and matched orders when effectuated "(f)or the purpose of creating a false or misleading appearance of active trading in any security registered on a national securities exchange, or ... with respect to the market for any such security." *Ernst & Ernst*, 425 U.S. at 205 n. 25, 96 S.Ct. 1375. "[T]he basic aim of the antifraud provisions is to prevent rigging of the market and to permit operation of the natural law of supply and demand.'" SEC v. First Jersey, Inc., 101 F.3d 1450, 1466 (2d Cir.1996) (citing United States v. Stein, 456 F.2d 844, 850 (2d Cir.)), cert. denied, (408 U.S. 922, 92 S.Ct. 2489, 33 L.Ed.2d 333 (1972)), cert. denied, 522 U.S. 812, 118 S.Ct. 57, 139 L.Ed.2d 21 (1977). "The gravamen of manipulation is deception of investors into believing that prices at which they purchase and sell securities are determined by the natural interplay of supply and demand, not rigged by manipulators." Gurary v. Winehouse, 190 F.3d 37, 45 (2d Cir.1999).manipulative or deceptive' used in conjunction with device or contrivance' strongly suggest that § 10(b) was intended to proscribe knowing or intentional conduct," and not merely negligence. 425 U.S. at 197, 199, 96 S.Ct. 1375. The dictionary defined "device' as (t)hat which is devised, or formed by design'; a contrivance; an invention; project; scheme; often a scheme to deceive; a stratagem; an artifice, and contrivance' in pertinent part as (a) thing contrived or used in contriving; a scheme, plan, or artifice.' In turn, contrive' in pertinent part is defined as (t)o devise; to plan, to plot ... (t)o fabricate ... design; invent ... to scheme.'" 425 U.S. at 199 n. 20, 96 S.Ct. 1375.are the official standards adopted by the American Institute of Certified Public Accountants (the "AICPA"), a private professional association, through three successor groups that it established, the Committee on Accounting Procedure, the Accounting Principles Board (the "APB"), and the Financial Accounting Standards Board (the "FASB").'" *In re K-tel Intern., Inc. Securities Litigation*, 300 F.3d 881, 889 (8th Cir.2002), quoting *Ganino v. Citizens Utils. Co.*, 228 F.3d 154, 160 n. 4 (2d Cir.2000). These rules apply to preparation of regular reports such as the 10-K and 10-Q form statements that publicly traded corporations must file annually or quarterly with the SEC. " There are 19 different GAAP sources, any number of which might present conflicting treatments of a particular accounting question.'" Id. at 889, quoting Shalala v. Guernsey Mem'l Hosp., 514 U.S. 87, 101, 115 S.Ct. 1232, 131 L.Ed.2d 106 (1995). Thus GAAP " are far from being a canonical set of rules that will ensure identical accounting treatment of identical transactions. [GAAP], rather, tolerate a range of "reasonable" treatments, leaving the choice among alternatives to management.'" *Id.*, quoting *Thor Power Tool Co. v. C.I.R.*, 439 U.S. 522, 544, 99 S.Ct. 773, 58 L.Ed.2d 785 (1979). "When ... conflicts arise, the accountant is directed to consult an elaborate hierarchy of GAAP sources to determine which treatment to follow.'" Id. "`In the event there is no official pronouncement, the consensus of the accounting profession, as manifested in textbooks, for example, determines GAAP.'" Id., quoting Providence Hosp. of Toppenish v. Shalala, 52 F.3d 213, 218 n. 7 (9th Cir.1995).fundamental purpose' of the Act as implementing a philosophy' of full disclosure.'" Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 477-78, 97 S.Ct. 1292, 51 L.Ed.2d 480 ... (1977), quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186, 84 S.Ct. 275, 11 L.Ed.2d 237 ... (1963).any manipulative or deceptive device or contrivance' in connection with the purchase or sale of any security [emphasis in original]"); *Superintendent of Insurance v. Bankers Life and Casualty Co.*, 404 U.S. 6, 11 n. 7, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971) ("10(b) and Rule 10b-5 prohibit all fraudulent schemes in connection with the purchase or sale of securities whether the artifices employed involved a garden type variety of fraud, or present a unique form of deception [emphasis in original]." [citation omitted]); Cooper v. Pickett, 137 F.3d 616, 624 (9th Cir.1997) (Central Bank "does not preclude liability based on allegations that a group of defendants acted together to violate the securities laws, as long as each defendant committed a manipulative or deceptive act in furtherance of the scheme"); ZZZZ Best, 864 F.Supp. at 971 ("It appears that the scope of deceptive devices or schemes prohibited by subsections (a) and (c) is quite extensive")(rejecting dismissal of plaintiffs' allegations that Ernst & Young was primarily liable for its participation in creating publicly released statements, issuing a review report, and failing to disclose additional material facts because the allegations taken as a whole might make it liable under a scheme to defraud). This Court does disagree with the Attorneys General where they step over the line to conspiracy and argue that participants in a scheme to defraud, no matter how small, are liable for other participants' conduct in furtherance of the scheme even if the participants did not commit a key act that itself violated § 10(b) and Rule 10b-5. The Court also differs with respect to Lead Plaintiff's analogy of liability under the securities statutes to that for criminal liability under wire fraud or mail fraud statutes in contending that a participant is liable for the conduct of all other participants in the scheme. The Court observes that in Central Bank, in rejecting the argument that the statue's language, "directly or indirectly," shows that the Congress intended to reach everyone who engages even indirectly in the proscribed activities, the Supreme Court noted that "the problem is that aiding and abetting liability extends beyond persons who engage even indirectly, in a proscribed activity; aiding and abetting liability reaches persons who do not engage in the proscribed activities at all, but who give a degree of aid to those who do." 511 U.S. at 176, 114 S.Ct. 1439. "Aiding and abetting is `a method by which courts create secondary liability' in persons other than the violator of the statute." Id. at 184, 114 S.Ct. 1439 (quoting Pinter v. Dahl, 486 U.S. 622, 648 n. 24, 108 S.Ct. 2063, 100 L.Ed.2d 658 (1988)). The Supreme Court commented that Congress "knew how to impose aiding and abetting liability when it chose to do so, did so in the general criminal statute" in 1995. Id. at 176, 114 S.Ct. 1439. Nevertheless Congress did not provide for private aiding and abetting liability in any of the causes of action in the securities statutes nor has it passed a general civil aiding and abetting statute, but has specified, when it desires to impose such liability, such liability in selected, individual statutes. Id. at 179, 182-83, 114 S.Ct. 1439. In 1995 in the PSLRA, Congress expressly gave only the SEC the right to pursue enforcement actions against aiders and abettors in securities actions, but did not proffer that right to plaintiffs in private civil actions. Id. at 183, 114 S.Ct. 1439; 15 U.S.C. § 78t(f). As will be further discussed, § 10(b) is silent about conspiracy liability and the securities statutes do not contain any provision authorizing a private cause of action for conspiratorial conduct. Dinsmore v. Squadron, Ellenoff, Plesent, Sheinfeld & Sorkin, 135 F.3d 837, 840-43 (2d Cir.1998) (holding "that where the requirements for primary liability [under § 10(b)] are not independently met, they may not be satisfied solely on one's participation in a conspiracy in which other parties have committed a primary violation"); In re Syntex Corp. Sec. Litig., 855 F.Supp. 1086, 1098 (N.D.Cal.1994), aff'd, 95 F.3d 922 (9th Cir.1996).purchased ... or sold ... securities of the same class' contemporaneously' with the insider transaction at issue." Clay v. Intern. Corp., 157 F.3d 1259, 1263 n. 5 (11th Cir.1998), vacated in part on other grounds, 176 F.3d 1381 (11th Cir.1999). As with control person liability under § 20(a) of the 1934 Act, liability under § 20A is derivative and requires proof of a separate underlying violation of the Act, such as a violation of § 10(b) and Rule 10b-5. In re Advanta Corp. Sec. Litig., 180 F.3d 525, 541 (3d Cir. 1999); Jackson National Ins. Co. v. Merrill Lynch & Co., Inc., 32 F.3d 697, 703 (2d Cir.1994) (reference to "this chapter" means that a plaintiff must plead a predicate violation of the 1934 Act or of rules and regulations promulgated thereunder); In re VeriFone Sec. Litig., 11 F.3d 865, 872 (9th Cir. 1993).unqualified' or clean audit is the highest level of assurance that an auditor can give an organization's financial statements. Accountants will qualify' their opinion where discrepancies are identified in a client's financial statements." In re Ikon Office Solutions, Inc., 277 F.3d 658, 663 n. 4 (3d Cir.2002).limited group' under Texas law [emphasis added by this Court]." *Id.* at 613, 614. In reaching its view of how Texas might apply § 552 to accountants, the panel merely relied on dicta in *Cook Consultants v. Larson*, 700 S.W.2d 231, 236 (Tex.App.-Dallas 1985, writ ref'd n.r.e.)(observing that the defendant was a surveyor "[u]nlike, for example, future purchasers of shares of stock attempting to hold an accountant liable, Larson is not a member of an unlimited class...."); *Blue Bell, Inc. v. Peat, Marwick, Mitchell & Co.*, 715 S.W.2d 408, 411 (Tex.App.-Dallas 1986, writ ref'd) (holding that "actual knowledge of a particular plaintiff is not necessary if the defendant should have had this knowledge" and that "when the auditors supplied the corporation with a number of audit reports, indicating knowledge by the auditors that third parties would be given these reports, one of a limited number of existing [as opposed to potential] trade creditors' was in a `limited group' under Texas law.") 81 F.3d at 614. Nevertheless, the Fifth Circuit did state, "[W]e do not suggest that a potential purchaser can never be a member of a limited group." Id. at 614. This Court finds that the facts in Scottish Heritable and the Texas cases it discusses are easily distinguishable from those alleged here, in many ways that are not necessary to explain. The key factor is that in Newby, Lead Plaintiff has alleged that a vital part of the Ponzi scheme was to draw in continually more and more investors' funds through the continued sale of Enron securities so that Enron could expand its operations (an expensive proposition given the allegations that the sham transactions it engaged in through the SPEs were financial "losers" and the SPEs served to conceal Enron's ever-increasing debt) and to pay down its existing debt, including to the bank Defendants participating with Enron in the scheme. Thus the potential investors were allegedly the intended targets of the reports and documents drafted and issued by Arthur Andersen and Vinson & Elkins, whether for Enron which they allegedly expected to use the misrepresentations to lure in more investment funds or for the public via SEC filings. As the Texas Supreme Court indicated in McCamish, the "limited group" restriction protects against unlimited liability: "[t]his formulation limits liability to situations in which the attorney who provides the information is aware of the nonclient and intends that the nonclient rely on the information." 991 S.W.2d at 793. That is the circumstance alleged in the consolidated complaint. Furthermore, in Pacific Mutual, although a fraudulent misrepresentation case, the plaintiff was an institutional investor that relied on audits subsequently included in statements and filings following a merger. The reason why the plaintiff lost was not that it was merely a potential investor, but because the statements it relied on were issued by a different entity than the one whose notes the plaintiff purchased and the prospectuses related to other securities issued later by the bank with which the first issuer merged.shifting the curve and making new deals to bury the losses from the past is constantly the strategy.' Another former trader stated: It was very simple. You just tweaked the assumptions on different variables, which were changed to make the return higher.'" Consolidated complaint at 305.