Only a week after agreeing to an embarrassing $2 billion settlement arising from its role as an underwriter of WorldCom bonds, JPMorgan Chase got some good news yesterday in a securities fraud case arising from its somewhat different dealings with Enron.
U.S. District Judge Sidney Stein granted JPMorgan’s motion to dismiss a securities class action that the bank’s shareholders brought on the theory that the bank had misled investors on its financial exposure arising from allegedly fraudulent transactions that the bank had entered into with Enron. The plaintiffs alleged that specific trading transactions between JPMorgan and Enron were really just disguised loans to Enron and that JP Morgan’s assistance to Enron in arranging off-balance sheet entities allowed Enron to hide debt. When news of JPMorgan’s alleged involvement in Enron became public in late 2001, the bank’s stock price fell, triggering the class action by the investors.
In the 61 page decision, Judge Stein carefully considered plaintiffs’ allegations, but concluded that plaintiffs failed to meet the standard of proof required in a securities class action and dismissed the claims. Inasmuch as the securities fraud claims must meet the heightened pleading standards set out in the 1995 Private Securities Litigation Reform Act, Judge Stein ruled that the plaintiffs were required to show that JPMorgan had made materially false statements with scienter. Establishing scienter is not an easy, as the plaintiffs must either show that JPMorgan had the motive and opportunity to commit fraud or show facts that constitute strong circumstantial evidence of conscious behavior or recklessness,
In his decision, Judge Stein found that plaintiffs offered generalizations rather than specific instances needed for scienter. Inasmuch as JPMorgan continued to fund Enron with new capital virtually up to the time of the company’s collapse, Judge Stein concluded that JPMorgan was unlikely to have known that Enron was on the brink of financial collapse. Consequently, Judge Stein reasoned that the bank could not have been expected to reveal its exposure in its financial statements before the Enron collapse actually took place.
Judge Stein did find that plaintiffs had pleaded scienter with the requisite particularity in connection with their allegation that JPMorgan’s prepay transactions with Enron were characterized as trading assets rather than as loan assets (an allegation that JPMorgan strongly disputes). However, Judge Stein ruled that, even assuming that the investors’ allegation on this technical accounting point is true, that distinction by itself was not material to investors.