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In re JP Morgan Chase Securities Litigation

March 29, 2007

IN RE: JP MORGAN CHASE SECURITIES LITIGATION


The opinion of the court was delivered by: Sidney H. Stein, U.S. District Judge

OPINION & ORDER

Plaintiffs in this action are shareholders of J.P. Morgan Chase & Co. and its predecessor, Chase Manhattan Corp., (collectively, "JPM Chase") who claim they were defrauded by the bank's complicity in Enron Corp.'s financial scandals. In essence, plaintiffs allege that that they invested in JPM Chase stock based on the company's reputation for integrity and financial discipline and ostensibly aboveboard bookkeeping whereas in reality, according to plaintiffs, JPM Chase was illegally and secretly aiding and abetting Enron's attempts to hide its massive financial liabilities.

In March 2005, the Court dismissed without prejudice plaintiffs' first amended complaint for failure to state a claim for relief pursuant to Fed. R. Civ. P. 12(b)(6) and for failure to comply with the heightened pleading standard required by Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act, 15 U.S.C. § 78u-4. See In re JPMorgan Chase Sec. Litig., 363 F. Supp. 2d 595 (S.D.N.Y. 2005). Plaintiffs have now filed a 322-page second amended complaint, which includes "volumes of new material from the Senate, SEC, Enron bankruptcy examiner investigations into JPMC's [allegedly] illicit conduct and evidence and opinions from the Worldcom litigation." (Pl.'s Opp. to Def.'s Motion to Dismiss at 1.) This version of the complaint, however, suffers from the same flaws as the first: If plaintiffs' allegations are borne out, it would be not they but the shareholders of Enron -- the real victims of the energy giant's collapse -- who would have been defrauded. The allegations in the second amended complaint fail to show, in a particularized fashion, that JPM Chase or its officers intended to deceive its own shareholders or in fact did deceive them in a material way. Accordingly, plaintiffs have again failed to state a claim for securities fraud. Defendants' motion to dismiss the second amended complaint is therefore granted with prejudice.

I. BACKGROUND

A. The First Amended Complaint

The Court presumes familiarity with its decision dismissing plaintiffs' First Amended and Consolidated Class Action Complaint for Violations of Federal Securities Laws ("FAC"), In re JP Morgan Chase, 363 F. Supp. 2d 595. Nonetheless, a brief recitation of the allegations in the FAC and the Court's findings as to those allegations is necessary to understand plaintiffs' second amended complaint.

The FAC alleged that during the class period -- from November 1999 through July 2002 -- JPM Chase defrauded its shareholders by concealing its complicity in the financial frauds perpetrated by Enron, which was one of JPM Chase's most lucrative clients. The FAC's principle allegation was that JPM Chase hid from its shareholders its creation of two shell corporations, Mahonia Ltd. and Mahonia Natural Gas Ltd., through which the bank provided Enron with billions of dollars in credit disguised as revenue from prepaid commodity trades ("prepays"). These "Mahonia transactions," according to the FAC, enabled Enron to conceal debt that otherwise would have appeared on its balance sheet; in exchange, JPM Chase charged Enron exorbitant "advisory" fees. The FAC also alleged that JPM Chase invested millions of dollars in one of Enron's money-spinning partnerships, LJM2, which allegedly was beneficial for the investors and utilized by Enron to consummate various sham transactions that hid the ownership risks of many of Enron's assets from its shareholders.

JPM Chase took these actions, according to the FAC, in order to (a) receive underwriting, consulting and commitment fees from Enron, as well as interest and other payments; (b) market its prepay services to other companies; (c) artificially inflate the price of JPM Chase stock, which the company could then use in stock-for-stock acquisitions of other financial institutions; (d) prevent Enron from defaulting on the hundreds of millions of dollars worth of credit default put options JPM Chase had written on Enron's publicly-traded debt; and (e) receive "kickbacks" in the form of opportunities to invest in LJM2. In addition, the two named individual defendants -- William Harrison, Jr., who was President and Chief Executive Officer of Chase Manhattan Corp. before the merger with J.P. Morgan & Co. and of J.P. Morgan Chase & Co. after the merger, and Marc. J. Shapiro, who was Vice Chairman of Chase before the merger -- allegedly benefited personally from the artificial stock price inflation by receiving large performance-based bonuses.

The FAC asserted that JPM Chase's conduct constituted violations of federal securities laws because the company hid from its shareholders, among other things, the risks inherent in the Mahonia transactions and JPM Chase's involvement in LJM2 through a series of misstatements on and omissions from its financial reports and other public disclosures. In particular, the FAC alleged that JPM Chase:

1) downplayed its Enron-related exposure by issuing deceptive press releases;

2) failed to disclose alleged violations of law in connection with the Mahonia and LJM2 transactions;

3) falsely portrayed itself as a low-risk company with a reputation for fiscal discipline and integrity;

4) permitted its analysts to issue misleading positive reports designating Enron's stock as a "buy"; and

5) improperly accounted for the Mahonia prepays as viable trades rather than impaired loans on its financial statements.

The FAC alleged that as a result of these misstatements and omissions, the price of JPM Chase stock became inflated above its inherent value, thereby defrauding the members of the proposed class. After JPM Chase's role in the Enron affair came to light in July 2002, its share price plummeted and the company, according to the FAC, lost part of its "reputation premium" for integrity that it had previously enjoyed.

B. The Court's Dismissal of the FAC

The Court evaluated the FAC in light of the heightened pleading standard mandated by Rule 9(b) of the Federal Rules of Civil Procedure, which provides that "circumstances constituting fraud or mistake shall be stated with particularity." Fed. R. Civ. P. 9(b). Accordingly, a plaintiff asserting a claim for securities fraud pursuant to section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j, and Rule 10b-5, 17 C.F.R. § 240.10b-5, must plead with particularity "that the defendant, in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that the plaintiff's reliance on the defendant's action caused injury to the plaintiff." Ganino v. Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000).

The Court found that the FAC failed to comply with these standards because it did not sufficiently allege scienter for all but the allegations involving JPM Chase's improper characterization of the Mahonia prepay transactions as trades, and for that allegation, plaintiffs did not properly plead materiality. See In re JP Morgan, 363 F. Supp. 2d at 619-634.

Specifically, in regard to scienter, the Court first found that plaintiffs failed to plead legally sufficient motive for any of the five categories of alleged misstatements and omissions.

Id. at 619-20. For each category, plaintiffs alleged the kinds of motives that can be imputed to all corporations and their officers -- such as the incentive to increase shareholder profit and officer compensation -- as opposed to the type of concrete and personal benefit that suffices to plead a strong inference of scienter. Id. at 621 (citing Kalnit v. Eichler, 264 F.3d 131, 139 (2d Cir. 2001)). The Court also pointed out that plaintiffs did not provide a rational incentive for the alleged fraud: why would JPM Chase continue to extend billions of dollars in credit to Enron (through the Mahonia prepays) if it was aware that Enron was on the verge of collapse? Id.

Second, the Court analyzed whether plaintiffs properly pleaded recklessness in regard to any of the categories of alleged misstatements because even in the absence of motive, "strong circumstantial evidence of conscious behavior or recklessness" can suffice to establish scienter pursuant to the securities laws. Id. at 619 (quoting Novak v. Kasaks, 216 F.3d 300, 310 (2d Cir. 2000) (internal quotation marks omitted)). The Court concluded as follows.

1. Alleged Downplaying of Enron-related Exposure

Plaintiffs asserted that JPM Chase acted recklessly in issuing a November 2001 press release that did not divulge the existence of significant insured liabilities connected to the Mahonia transactions. Id. at 634. The Court found, however, that because the Mahonia transactions were insured, the November press release did not contain a material falsehood. Id. Plaintiffs offered only "conclusory allegations that JPM Chase should have known that the insurers would challenge those contracts or that those challenges might be successful." Id. Plaintiffs also failed to set forth any particularized allegations indicating that JPM Chase's other statements allegedly downplaying its Enron-related exposure "were false when made or that they constituted more than immaterial puffery." Id.

2. Alleged Failure to Disclose Violations of Law

The FAC alleged that JPM Chase made material omissions in failing to disclose legal violations in connection with the Mahonia transactions and the company's investment in LJM2. Id. at 624, 632. These allegations failed, however, because they were strictly conclusory: plaintiffs offered no specific allegations supporting the conclusion that investment opportunities in LJM2 or other Enron special purpose entities constituted illicit "kickbacks" in exchange for loans to Enron or that these opportunities were otherwise illegal. Id. Plaintiffs also proffered no allegations showing that defendants knowingly made material misstatements or omissions to government regulators or financial institutions. Id. at 632.

3. Alleged Falsities in Portraying Itself as a Low-Risk Company Plaintiffs alleged that JPM

Chase repeatedly misrepresented itself as a low-risk company with adequate financial discipline to manage risks. Id. at 612. The Court found, however, that JPM's statements regarding corporate integrity, fiscal discipline and risk management amounted to "no more than puffery" and thus were inactionable under the securities laws. Id. at 632-33 ...


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