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MERRILL LYNCH & CO., INC. v. ALLEGHENY ENERGY

July 18, 2005.

MERRILL LYNCH & CO., INC., MERRILL LYNCH CAPITAL SERVICES INC., and ML IBK POSITIONS, INC., Plaintiffs,
v.
ALLEGHENY ENERGY, INC., Defendant. ALLEGHENY ENERGY, INC., AND ALLEGHENY ENERGY SUPPLY CO., LLC., Counterclaim-Plaintiffs, v. MERRILL LYNCH & CO., INC., and MERRILL LYNCH CAPITAL SERVICES, INC., Counterclaim-Defendants.



The opinion of the court was delivered by: HAROLD BAER, JR., District Judge

OPINION & ORDER

Plaintiffs filed this action on September 24, 2002 and Defendants filed counterclaims. A bench trial was conducted on May 9-12, 16-18, and 20, 2005, with respect to the damages due to Merrill Lynch on its breach of contract claim and with respect to Allegheny's remaining counterclaims for fraudulent inducement and breach of contract. The parties submitted post-trial briefs on May 27, 2005, closing arguments were held on June 3, 2005, and the action became sub judice after the parties submitted proposed findings of fact on June 10, 2005.

I. PROCEDURAL HISTORY

  Plaintiffs Merrill Lynch & Co., Inc., Merrill Lynch Capital Services Inc., and ML IBK Positions, Inc. (collectively "Merrill Lynch") filed this action on September 24, 2002 for a single breach of contract claim. Defendants and Counterclaim Plaintiffs Allegheny Energy, Inc., Allegheny Energy Supply Co., LLC. (collectively "Allegheny") filed counterclaims for rescission, fraudulent inducement, breach of contract, and breach of fiduciary duty. Merrill Lynch moved to dismiss and on November 25, 2003, this Court (1) granted Merrill Lynch's motion to dismiss Allegheny's rescission claim, the punitive damages claim based upon fraudulent inducement, and the jury demand; and (2) denied Merrill Lynch's motion to dismiss the fraudulent inducement claim, the breach of contract claim, the breach of fiduciary duty claim, and the punitive damages claim based upon a breach of fiduciary duty. Merrill Lynch & Co., Inc. v. Allegheny Energy, Inc., 2003 U.S. Dist. LEXIS 21122 (S.D.N.Y. May 30, 2003). Subsequently, Allegheny moved for leave to amend its counterclaims. On October 26, 2004, the Court granted Allegheny leave to amend but not with respect to punitive damages on its fraud counterclaim or its renewed demand for a jury trial. The Court also denied production of two reports written in connection with an internal investigation sought by Allegheny. Merrill Lynch, 2004 U.S. Dist. LEXIS 21543 (S.D.N.Y. Oct. 22, 2004). On April 12, 2005 the Court granted summary judgment to Merrill Lynch with respect to its breach of contract claim and dismissed Allegheny's counterclaims for negligent misrepresentation, breach of fiduciary duty and aiding and abetting such a breach. Merrill Lynch, 2005 U.S. Dist. LEXIS 6073 (S.D.N.Y. Apr. 12, 2005). On May 9, 2005 a bench trial commenced to determine the damages owed to Merrill Lynch on its breach of contract claim and Allegheny's breach of contract and fraudulent inducement claims, the only remaining claims.

  II. FINDINGS OF FACT

  This case arises out of Allegheny's purchase of Merrill Lynch's energy-commodities trading business known as Global Energy Markets ("GEM") for $605 million ($490 million in cash and a 2% equity interest in Allegheny Supply ("Supply")).*fn1 It's a saga of missteps taken by two of America's largest and most respected entities and which it is sad to say can only be characterized as having happened through a combination of complacency and greed. Merrill Lynch brought suit to enforce a provision in the Asset Contribution and Purchase Agreement ("Purchase Agreement") that provided that if Allegheny did not contribute certain assets to Supply, Merrill Lynch had the right to "put" its equity position in Supply back to Allegheny Energy for $115 million plus interest. Allegheny brought its counterclaims against Merrill Lynch for inter alia fraudulent inducement and breach of contract.

  A. Negotiations to Sell the GEM

  In 2000, Merrill Lynch, Allegheny's long time financial advisor began at Allegheny's behest to advise it about acquiring a sophisticated energy trading operation. After a discussion of several potential transactions, a senior investment banker at Merrill Lynch suggested that Allegheny consider the acquisition of Merrill Lynch's own energy trading operation, GEM. At or about that time, and in order to avoid any potential conflict, Allegheny retained Salomon Smith Barney to replace Merrill Lynch as its financial advisor and on September 1, 2000, the parties met and negotiations for GEM began in earnest. Both sides conducted extensive two-way due diligence because part of the purchase price included an equity stake in Supply. In addition to a "revered" financial advisor, Salomon Smith Barney, Allegheny retained a "revered" law firm, Sullivan & Cromwell, with a specialty in mergers and acquisitions. To top it off, Price Waterhouse Coopers was retained as their auditor. While in light of what happened it seems incredible, Allegheny paid some $6 million over a period of four months for the combined services of these due diligence experts. (Blasko Tr. at 885:09.)

  i. September Financial Statements

  Allegheny was promised financial information about the GEM business unit within one week of the September 1 meeting, and it was understood that the forthcoming financial information was to include historical financial performance and projections. On September 8, a fax was sent to Allegheny that reported GEM's operating revenues for 1999 as $49 million, after tax earnings of $25 million and year-end operating revenues of $72.5 million. (DX 70.) The plot thickens when Flavio Bartmann, the head of the deal team at Merrill Lynch and listed signatory on the cover page, claimed on the witness stand that he had neither sent the fax nor authorized it to be sent. (Flavio Bartmann Tr. at at 227:1.) Apparently his secretary sent it, although no one at Merrill Lynch bothered to investigate or explain on the stand who instructed her to do so. On September 22, a second identical set of financial statements was delivered to Allegheny, to this Bartmann admits authorship. (DX 85.)

  Merrill Lynch does not dispute the fact that neither statement was the product of the Finance Department, the department where, as the evidence made crystal clear, all such statements must be initiated. Speculation points to Dan Gordon as the culprit who, while at the helm of GEM had in a related transaction, embezzled $43 million dollars from Merrill Lynch. In his plea allocution on that criminal charge, Gordon stated that, as per a decision made by his superiors, he "alter[ed] certain data" in connection with the transaction to make the GEM "look more profitable," (DX 300), about which more later. It is worth noting that the revenues and projections forwarded in September were higher than those in Merrill Lynch's books and records, (DX 719, DX 311) records one might have thought Alleghey would have sought and perused. Bartmann claims not to have known the financial information was unreliable and had no reason to suspect it did not come from the Finance Department. (Bartmann Tr. at 229:23.) At best, Bartmann, as head of the deal team, was careless when he failed to discover that the financial information sent twice, at least once with his knowledge, was unreliable.

  ii. Valuation of the Williams Contract

  Allegheny requested year-to-date financials for GEM that included profits and losses ("P&L") attributable to the Williams Contract, GEM's largest single trading asset. (DX 327.) Williams Energy Marketing & Trading is a Southern California energy provider. The Williams Contract gave Merrill Lynch a series a daily options for a period of 18 years to call upon Williams for up to 1,000 MW of electricity generated from power plants in Southern California. (PX 36.) This request came about during a two day due diligence session. During these negotiations, Allegheny's Executive Director of Business Development, Peter Dailey, told Gordon that without current figures for GEM, Allegheny was prepared to pursue a deal with Morgan Stanley. (DX 112.) In an email to the Merrill Lynch deal team the next morning Gordon stated that it was "imperative" that Merrill Lynch "immediately" provide year-to-date financials including the Williams P&L. At the second day of the due diligence meeting, Bartmann informed Allegheny's representatives that Merrill Lynch was provisionally recognizing $32 million in Profit on the Williams Contract. Bartmann and Ahmass Fakahany, a Finance Director at Merrill Lynch, reached and sent on this "provisional" or "indicative" figure with little or no time for reflection and opined that the valuation methodology was still in development. (Ahmass Fakahany Tr. at 844:02-04.)

  On October 11, Bartmann sent a third financial statement to Allegheny reflecting year-to-date financial reserves, including the release of a Williams Reserve of approximately $32 million to be added to revenues. (DX 110.) Again the document appears to come from Bartmann but once again Bartmann, the head of the deal team, denies he sent it. Of even more concern, Fakahany testified that he did not authorize Bartmann to send such a financial statement and there was ...


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