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Merrill Lynch, Credit Suisse Not Off the Hook for Enron Liability

Thirty states have taken the side of Enron shareholders seeking damages from big investment banks in a federal case over the banks' alleged role in Enron's accounting fraud.

The states' move puts them at odds with a legal stance the Securities and Exchange Commission staff had considered taking in support of one of the banks, Merrill Lynch & Co. (MER), but appears now to have decided against.

In a brief filed Monday in a federal appeals court, attorneys general from the 30 states use the SEC's legal arguments in 2002 Enron litigation to make the case that Merrill, Credit Suisse and the other investment banks should be held liable as participants in accounting fraud. The SEC pursued Merrill, JP Morgan Chase & Co. and Citigroup Inc. over their role in Enron's scheme, winning tens of millions of dollars in settlements with the investment powerhouses in 2003.

The states, in the brief written by Texas Attorney General Greg Abbott, maintain that the Wall Street banks are liable "for directly participating in the Enron securities fraud" and "for manipulative and deceptive devices and contrivances." Residents of the 30 states who were shareholders were injured by Enron's collapse, "and their rights, and the rights of other innocent citizens in future Enrons should be protected," the filing says.

As previously reported by The Associated Press, attorneys for Merrill recently asked the SEC to file a brief in the 5th U.S. Circuit Court of Appeals in New Orleans in support of the firm's position that on legal grounds, it should not be held liable in the case — and the agency staff had considered doing so.

The staff is not expected to recommend to the SEC commissioners that the agency file such a brief in the case, making it unlikely that it will happen, a person familiar with the matter said Tuesday. He spoke on condition of anonymity because he was not authorized to speak officially on the matter.

The lawsuit on behalf of Enron shareholders seeks billions of dollars in damages from the investment banks. The federal judge presiding over the litigation, U.S. District Judge Melinda Harmon in Houston, has granted it status to proceed as a class-action suit. That decision is being reviewed by the appeals court in New Orleans. If the appeals court overturned Harmon's ruling, the suit against the investment banks could be tossed out.

Merrill's position, as expressed in papers it filed last month, is that in granting class-action status to the shareholders, a federal judge accepted an "expansive" theory put forward by their attorneys that wrongly holds all parties — including those that aided Enron's scheme but didn't know its true purpose— liable for losses sustained by investors.

The attorneys representing Enron shareholders argue that the investment banks played key roles in Enron's "scheme to defraud." Under a 1995 law, a single defendant can be held liable for paying the entire amount of damages if the judge determines that the defendant knowingly violated the securities laws.

The 28-page brief filed by the 30 states cites criteria proposed in 2002 by the SEC in legal arguments to determine liability of participants in a deceptive scheme. The idea expounded by the SEC was that deception in the form of a false picture of a company's revenues can be made by acts as well as words.

That means a participant in a scheme would do more than aid and abet it, by engaging in a transaction whose main purpose is to create such a false financial picture — and therefore should be held liable.

To accept the investment banks' interpretation of legal precedent "would result in virtual immunity for banks, law firms, accountants and other securities professionals from private liability in many cases," the states' brief says. Contradicting the securities laws, it says, is "the view that those crafty enough to benefit from participating in a securities fraud while carefully avoiding the public attribution of a false statement to them can escape liability. ..."

Andrew Fastow, Enron's now-imprisoned former finance chief pegged as the mastermind behind the complex financial schemes that ultimately doomed the high-flying energy company, provided testimony this fall in the shareholder litigation.

He answered yes, for example, when asked whether some of the transactions Enron conducted with its investment banks created the false appearance of profits and cash flow.

In addition to Texas, the attorneys general signing the brief were from Alabama, Arizona, Arkansas, California, Connecticut, Georgia, Hawaii, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland, Michigan, Minnesota, Mississippi, Montana, New Hampshire, New Jersey, New Mexico, North Dakota, Oklahoma, Oregon, Pennsylvania, South Carolina, South Dakota, Utah, Vermont and West Virginia.

In 2003, Merrill agreed to pay $80 million to settle the SEC's civil charges that it participated in Enron's phony sales of floating power plants, designed to inflate the company's earnings in 1999. The firm neither admitted nor denied wrongdoing in the settlement.

JP Morgan Chase and Citigroup also paid civil fines in similar agreements with the SEC. Four former Merrill executives were convicted of fraud and conspiracy in 2004 for their roles in the deal.

Along with Merrill and Credit Suisse, other defendants in the shareholders' suit are Royal Bank of Canada, Royal Bank of Scotland and Toronto-Dominion Bank.