Federal District Court Opinions

IN RE ENRON CORP. SECURITIES, DERIVATIVE & “ERISA” LITIG.,
(S.D.Tex. 2003) In Re ENRON CORPORATION SECURITIES,
DERIVATIVE & “ERISA” LITIGATION; MARK NEWBY, et al.,
Plaintiffs VS. ENRON CORPORATION, et al., Defendants;
SILVERCREEK MANAGEMENT, INC. et al., Plaintiffs, VS. SALMON
SMITH BARNEY, INC., et al., Defendants CIVIL ACTION NO.
H-01-3624 AND CONSOLIDATED CASES, CIVIL ACTION NO.
H-02-3185 United States District Court, S.D. Texas.
December 10, 2003

MEMORANDUM AND ORDER OF PARTIAL DISMISSAL

MELINDA HARMON, District Judge

Pending before the Court in H-02-3185, transferred from the
United States District Court in the Southern District of
New York by the Panel on Multidistrict Litigation for
consolidation with MDL 1446, are the following motions:

(1) Defendant Goldman, Sachs & Co.’s (“Goldman, Sachs'”)
motion to dismiss the complaint for failure to state a
claim for which relief can be granted and failure to plead
with particularity, or alternatively, to compel
arbitration of the two common law claims (instrument #7);
Page 2

(2) Defendant Salomon Smith Barney, Inc.’s motion for an
order to dismiss for failure to state a claim upon which
relief can be granted (#10);

(3) Defendants Bane of America Securities LLC’s (“BA’s”)
motion to dismiss complaint with prejudice (#14);

(4) Goldman Sachs’ motion for leave of court to
supplement the record in support of its alternative motion
to compel arbitration by filing the affidavit of Kim
Cuomo, which is submitted to authenticate the account
agreements giving rise to Goldman Sachs’ alternative
motion to compel arbitration (#1312 in Newby; #62 in
H-02-3185).

This suit, H-02-3185, in essence arises out of the same
pyramid scheme alleged in great detail in Newby, in
particular the illicit special purpose entities controlled
by Enron and utilized for undisclosed off-the-books
transactions involving sham hedging and loans disguised as
sales that materially distorted Enron’s reported financial
results in financial statements prepared by and continually
supported by Defendants here and thereby defrauded Enron
investors, including Plaintiffs Silvercreek Management
Inc., Silvercreek Limited Partnership, Silvercreek II
Limited, Onex Industrial Partners Limited, and Pebble
Limited Partnership. Page 3

Plaintiff Silvercreek Management, Inc. represents that it
“is an institutional money manager, and the other
Plaintiffs are investment entities for which Silvercreek
Management serves as an investment manager.” #28, citing
§§ 8-12 of the original complaint.
Plaintiffs’ initial complaint states that they purchased
over $175 million in Enron debt securities during October
2001, just before Enron’s crash, and lost approximately
$122 million as a result. The complaint asserts that
Defendants participated in, conspired with other
wrongdoers, and aided and abetted in the wrongful conduct
comprising the fraudulent scheme.

The motions to dismiss relate to the original complaint
(#1), which specifically asserts (1) against Salomon Smith
Barney, Goldman Sachs and BA (collectively, “the
underwriter Defendants”) common law claims for “fraud and
deceit” and for negligent misrepresentation, under New York
law, as well as violations of Section 11 of the Securities
Act of 1933, 15 U.S.C. § 77k, relating to Enron 7%
Exchangeable Notes; and (2) against Defendant Salomon Smith
Barney, Section 11 claims relating to Enron Zero Coupon
Notes. That original complaint has since been superseded by
stipulation (#65) by Plaintiffs’ first amended complaint
(#61), which adds causes of action for violations of 15
U.S.C. § 10(b) and Rule 10b-5, 17 U.S.C. §
240.10b-5, and of 15 U.S.C. § 20(a) of the
Securities Exchange Act of 1934, and violations of Article
81-1 of the Texas Securities Act, extends its section 11
claims relating to the Zero Coupon Notes to all three
Defendants, and provides more detailed factual allegations
about the underwriter Page 4 Defendants’ involvement in
the alleged fraudulent scheme.[fn1] Another original
Defendant, Arthur Andersen LLP, Enron’s outside auditor and
certifier of Enron’s financial statements with unqualified
audit opinions that were filed directly with the SEC and
that were also later incorporated by reference into Enron’s
registration statements for both note offerings at issue,
has not moved to dismiss any claims against it or its
officers and employees. For these reasons the pending
motions to dismiss are actually for partial dismissal of
causes of action against the three underwriter Defendants.

In particular the original complaint alleges that Salomon
Smith Barney, Goldman Sachs, and BA served as underwriters
on Enron’s July 1999 public offering of 7% Exchangeable
Notes,[fn2] which were mandatorily exchangeable into Enron
common stock of Page 5 Enron’s partially owned subsidiary,
Enron Oil & Gas Company.[fn3] The underwriter Defendants
also served as initial purchasers of Zero Coupon
Convertible Senior Notes, debt securities that were
convertible into Enron common stock, offered beginning in
June 2001,[fn4] shortly before Enron was forced to restate
its financial results for the previous four years.[fn5]
Plaintiffs purchased their 7% Exchangeable Notes between
October 24-26, 2001.

The initial complaint alleges generally that Defendants
Goldman Sachs, Salomon Smith Barney, and BA were
underwriters for Enron’s multiple securities offerings for
a number of years and that they participated in the two
note offerings at issue, the 7% Exchangeable Notes and the
Zero Coupon Notes, and in other wrongful financial
transactions for Enron and its subsidiaries and affiliates.
They allegedly reviewed the purportedly materially false
financial statements and prospectuses filed with the SEC
on Page 6 Enron’s behalf during 1999 and 2001, on which
Plaintiffs claim they primarily relied in deciding to
purchase the Enron debt securities at issue. According to
the original complaint these “Wall [S]treet firms provided
the financial grease which let Enron grow into the Nation’s
seventh largest company, and in the process these firms
earned $214 million in underwriting fees alone, and much
more for lending, derivatives trading and merger advice.”
#1 at 1-2. The underwriter Defendants, despite having full
access to Enron’s records, allegedly failed to perform
adequate due diligence that would have uncovered Enron’s
fraud and Enron’s deceptive financial statements, certified
by co-conspirator Arthur Andersen LLP, nor did they
adequately disclose the risks of the purchase of the notes
to Plaintiffs. Moreover the complaint charges that because
Defendants’ brokerage personnel were directly involved in
selling the Enron debt securities to Plaintiffs, the
underwriter Defendants also breached “heightened fiduciary
obligations to Plaintiffs.” Id. at 2. Furthermore, even as
Enron was imploding, the underwriter Defendants continued
to recommend that Plaintiffs and the public purchase the
notes at issue.

The Court first addresses Goldman Sachs’ motions. Because
the Court finds no prejudice to Plaintiffs Silvercreek
Management Inc., Silvercreek Limited Partnership,
Silvercreek II Limited, Onex Industrial Partners Limited,
and Pebble Limited Partnership from allowing Goldman Sachs
to supplement, and because Plaintiffs in their opposition
(#64) have not argued there is any, the Court grants the
motion to supplement (#62) with Kim Cuomo’s affidavit.
Page 7

As its first ground for dismissal, Goldman Sachs contends
Plaintiffs’ initial complaint fails to adequately plead
reliance, an essential element of common law fraud and
negligent misrepresentation and of Plaintiffs’ §
11(a) claim against Goldman Sachs. Instead, insists Goldman
Sachs, Plaintiffs have merely asserted a single,
bare-bones, conclusory allegation of reliance, which is
insufficient. Section 11(a) itself requires a showing of
actual reliance rather than presumed reliance after a
twelve-month period following the effective date of the
prospectus and registration statement. Moreover, Goldman
Sachs maintains that Plaintiffs’ factual assertions that
they “read, reviewed and relied upon” Enron financial
statements for 2000 and 2001 (Complaint at § 152),
as well as the nature of Plaintiffs’ business in trading in
distressed securities, their arbitrage strategy, and their
purchase of the Enron debt securities after publicized
negative news about Enron, negate any claim of justifiable
reliance on the old 1997 and 1998 financial statements by
Plaintiffs as a matter of law.[fn6] Goldman Sachs cites New
York Page 8 case law concluding that where plaintiffs are
“sophisticated businessmen,” as Goldman Sachs characterizes
Plaintiffs here,[fn7] a Page 9 Page 10 claim of
justifiable reliance on three-to-four-year-old financial
statements is undermined as a matter of law. See, e.g., In
re Livent, Inc. Noteholders Sec. Litig., 151 F. Supp.2d 371
(S.D.N.Y. 2001); Grumman Allied Indus., Inc. v. Rohr Indus.
Inc., 748 F.2d 729, 737 (2d Cir. 1984); Stuart Silver
Assocs. v. Baco Dev. Corp., 665 N.Y.S.2d 415, 417-18 (1st
Dep’t 1997).

Insisting that the entire complaint “sounds in fraud,”
Goldman Sachs also moves to dismiss for failure to comply
with the requirement of Fed. Rule of Civil Procedure 9(b)
that a plaintiff plead with particularity. Goldman Sachs
maintains there are no particularized allegations of fraud
(alleged fraudulent statements, speaker, when and where the
statements were made, and why the statements were
fraudulent when made) against it, nor of allegations of
conspiracy, aiding and abetting, and common course of
conduct. It also emphasizes that the complaint does not
allege that Goldman Sachs underwrote the Zero Coupon notes
or had any communications with Plaintiffs about their Enron
trades. Nor do their allegations support scienter, i.e.,
Plaintiffs fail to assert facts creating a strong inference
of fraudulent intent. Even the charge that Defendants
should have uncovered the alleged wrongdoing by due
diligence is conclusory and insufficient to satisfy Rule
9(b), argues Goldman Sachs.

Goldman Sachs also contends that Plaintiffs have failed to
allege any misrepresentation or omission by it or to show
a Page 11 duty on the part of Plaintiffs to speak and/or
disclose, to support Plaintiffs’ claims of fraud or
negligent misrepresentation.

Finally, Goldman Sachs incorporates the arguments of
Salomon Smith Barney and BA, which in essence duplicate its
own with respect to the claims asserted against each; they
in turn adopt Goldman Sachs’ objections.

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