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Silvercreek Management, Inc. v. Citigroup, Inc.

United States District Court, S.D. New York

March 31, 2017

SILVERCREEK MANAGEMENT, INC., et al., Plaintiffs,
v.
CITIGROUP, INC., et al., Defendants.

          OPINION AND ORDER

          J. PAUL OETKEN, District Judge

         Plaintiffs, a group of investment funds, brought this action against Defendants, a set of financial institutions and individuals, for conduct relating to the issuance of debt securities by Enron Corporation (“Enron”).[1] (See Dkt. No. 10-115 (“TAC”).) Plaintiffs assert claims under state tort law and federal securities law. Although filed in this Court in 2002, this action was consolidated with numerous other Enron-related actions in an MDL proceeding in Texas for several years, returning to this Court in 2016. Defendants move to dismiss Plaintiffs' complaint for failure to state a claim. For the reasons that follow, the motion is granted in part and denied in part.

         I. Background

         This action has been pending since 2002 and involves allegations of misconduct relating to the collapse of Enron. In October of 2001, Plaintiffs invested over $100 million in 7% Exchangeable Notes (the “7% Notes”) and Zero Coupon Exchangeable Notes (the “Zero Notes”) issued by Enron. (TAC ¶ 1.) At the time, Enron was the world's largest energy trader and was engaged in a variety of other related and unrelated businesses. (Id.)

         In a story that is by now well known, Enron's success was not to last. In late 2001, Enron was forced to restate its financial results for the previous four years. (Id. ¶ 2.) The restatements, which dramatically reduced Enron's reported income and increased its reported debt, stemmed from the company's use of unconsolidated special purpose entities (“SPEs”) and off-balance-sheet transactions.[2] (Id.) In their complaint, Plaintiffs describe several specific SPE transactions in great detail. (Id. ¶¶ 183-248.) Enron also engaged in a variety of other transactions such as prepay contracts (“prepays”), [3] minority-interest transactions, [4] and tax-driven transactions.[5] (Id. ¶¶ 249-262.) Enron filed for bankruptcy shortly after its financial restatement, and its auditor, Arthur Andersen LLP (“Arthur Andersen”), was found guilty of obstruction of justice and ultimately folded. (Id. ¶ 3.)

         Plaintiffs claim that, in investing in Enron's debt securities, they relied upon information contained and incorporated in the securities' prospectuses and registration statements, public disclosures and representations made by Enron management, and research reports and commentary by investment research analysts. (Id. ¶¶ 4, 106-111, 164.) The heart of Plaintiffs' claim is that Enron, and the individuals and institutions serving Enron, engaged in financial engineering designed to mislead investors and the public about the financial health of the firm. In this action, Plaintiffs seek to hold responsible the banks and individuals they allege are responsible for their losses. (Id. ¶ 5.)

         This background section will first briefly introduce each of the Defendants[6] (their actions in relation to Enron will be described in greater detail below) and will then provide an overview of the history of this action, from its initiation in 2002 through the present motion.

         A. Current Defendants

         Defendants at issue in this motion to dismiss are three financial institutions-Credit Suisse, Deutsche Bank, and Merrill Lynch-and one Enron executive-Skilling.

         Plaintiffs allege that Defendant Credit Suisse was an underwriter of the Zero Notes offering and provided commercial and investment banking services to Enron, including by structuring Enron's prepay transactions and SPEs. (Id. ¶¶ 28, 31.) Credit Suisse also had a business relationship with Silvercreek, providing brokerage services, research reports, and investment advice. (Id. ¶ 30.)

         Plaintiffs allege that Defendant Deutsche Bank provided commercial and investment banking services to Enron. (Id. ¶ 20.) Plaintiffs allege that Deutsche Bank “had a close relationship with Enron” and “knew that Enron was falsifying its financial reports.” (Id. ¶ 341.) In particular, Plaintiffs allege that Deutsche Bank helped Enron structure multiple tax-related transactions and set up and finance SPEs. (Id. ¶ 20.) These transactions included eleven SPE transactions from 1995 to 2001, and a variety of other allegedly fraudulent schemes. (Id. ¶ 341.)

         Plaintiffs allege that Defendant Merrill Lynch provided commercial and investment banking services to Enron. (Id. ¶ 35.) In particular, they allege that Merrill Lynch helped Enron structure and finance SPEs and participated in transactions designed to mischaracterize loans as purchase and/or sale transactions, another effort to cover up Enron's indebtedness. (Id.)

         Defendant Jeffrey Skilling served in a variety of executive leadership roles at Enron. He was President from 1997 to August 2001, Chief Operating Officer from January 1997 to February 2001, a Director from 1997, and Chief Executive Officer from February to August 2011. (Id. ¶ 39.) Skilling was ultimately convicted of securities fraud, sentenced to 24 years in prison, and fined $45 million; his conviction was affirmed in part by the United States Supreme Court. (Id. ¶ 40.) See Skilling v. United States, 561 U.S. 358 (2010). Plaintiffs allege that Skilling was “directly involved in creating and overseeing the off-book entities and fraudulent financial transactions which were used to inflate Enron's reported earnings and underreport Enron's debt.” (TAC ¶ 264.)

         B. Procedural Background

         This action arrives at this Court more than a decade after the incidents giving rise to its claims. The suit was initially filed in the Southern District of New York on November 7, 2002. (Dkt. No. 1.) The case was assigned to then-District Judge Gerard E. Lynch. (Dkt. No. 3.) Several months later, it was transferred for pretrial purposes to the Southern District of Texas by the Judicial Panel on Multidistrict Litigation, where it was consolidated as part of the Enron Multidistrict Litigation (“MDL”), Number 1446, for which the lead case was Newby v. Enron Corp., No. H-011-3624 (S.D. Tex.). (Dkt. No. 5.) Discovery in this action was completed by 2006 (with some exceptions) in accordance with the case management plan governing the Newby action. (Dkt. No. 27 at 1-2.)

         On July 5, 2006, the MDL Court certified a plaintiff class; the Silvercreek Plaintiffs opted out of the class. (Id. at 2.) This action, and the other opt-out actions, were then stayed pending resolution of the Newby class action. (Id.)

         On June 25, 2010, after the conclusion of the Newby action, the Silvercreek Plaintiffs moved to lift the stay and for leave to file a third amended complaint. (Id.) The MDL Court lifted the stay and granted leave to amend. (Dkt. No. 10-120.) The Silvercreek Plaintiffs filed the operative Complaint (the “TAC”) in August 2011. (See TAC.) As discussed above, the TAC names five Financial Institution Defendants-Barclays, Credit Suisse, Deutsche Bank, JPMorgan, and Merrill Lynch-and six Enron Director/Officer Defendants-Fastow, Skilling, Causey, Buy, Derrick, and the Estate of Kenneth Lay. (Id.)

         The Financial Institution Defendants jointly moved to dismiss the TAC in the Texas Court in September of 2011. (Dkt. Nos. 10-123, 10-124.) Causey and Skilling filed answers, and Skilling also joined in the motion to dismiss. (Dkt. Nos. 10-122, 10-130, 10-131.) After the completion of briefing, Silvercreek settled with Barclays and JPMorgan. (Dkt. Nos. 10-148, 10-161.) Fastow, Buy, Derrick, and the Estate of Lay have, to date, not responded. (Dkt. No. 27 at 2.)

         On March 21, 2016, Silvercreek filed a motion before the Judicial Panel on Multidistrict Litigation for remand to this District, which was granted. (Dkt. Nos. 9, 10-183.) The case was assigned to this Court on June 15, 2016. (Dkt. No. 11.) In light of the intervening years and developments since the initial filing of the motion to dismiss, the parties sought leave from this Court to submit new briefing on the pending motion to dismiss. (Dkt. No. 27.) The Court granted that request. (Dkt. No. 37.) The Court now considers that motion.

         The Court also notes that in ruling on these claims, it is not writing on a blank slate-far from it. Much ink has been spilled, mostly by the MDL Court, but also by the Fifth Circuit, addressing claims arising from Enron's demise. While those rulings do not have precedential effect in this action, and the Court relies on the particularities of the circumstances here (as described in Silvercreek's Complaint) in arriving at its decision, such rulings provide helpful guidance.

         II. Legal Standard

         To survive a Rule 12(b)(6) motion to dismiss, a plaintiff must allege “enough facts to state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). A claim is facially plausible “when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). In considering a motion to dismiss, courts must accept as true all “factual allegations contained in the complaint, ” Twombly, 550 U.S. at 572, and must draw “all inferences in the light most favorable to the non-moving party, ” In re NYSE Specialists Sec. Litig., 503 F.3d 89, 95 (2d Cir. 2007) (Sotomayor, J.).

         Under Federal Rule of Civil Procedure 9(b), a plaintiff alleging fraud must state its claim “with particularity.” Fed.R.Civ.P. 9(b). The Second Circuit has “held that Rule 9(b) requires that a complaint ‘(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent.'” DiMuro v. Clinique Labs., LLC, 572 Fed App'x 27, 30 (2d Cir. 2014) (quoting Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993)).

         III. Discussion

         The Court first addresses each of the individual claims challenged by the Financial Institution Defendants, and concludes with an analysis of the issues relating to Skilling.

         A. Common Law Fraud (Count Four)

         In order to plead fraud under New York law, a plaintiff must allege[7] (a) a material misrepresentation or omission of fact; (b) defendant's knowledge of the falsity of the statement; (c) intent to defraud; (d) reasonable reliance by the plaintiff; and (e) damage to the plaintiff. See Crigger v. Fahnestock & Co., 443 F.3d 230, 234 (2d Cir. 2006). Because the claim is for fraud, it must satisfy the heightened pleading requirements of Rule 9(b). This requires a plaintiff to specify the fraudulent statements, identify the speaker, state when and where the statements were made, and explain why the statements were fraudulent. Eternity Glob. Master Fund Ltd. v. Morgan Guar. Trust Co. of N.Y., 375 F.3d 168, 186-87 (2d Cir. 2004).

         To support its claim of fraud, Silvercreek alleges that it had longstanding relationships with Merrill Lynch and Credit Suisse, that it regularly communicated with their representatives regarding potential investments, and that it paid them hundreds of thousands of dollars in brokerage-related fees. (TAC ¶¶ 675, 792-94.) Silvercreek argues that this close relationship led it to trust Credit Suisse and Merrill Lynch. (Id.)

         Silvercreek contends that, in October 2001, representatives of Credit Suisse and Merrill Lynch recommended Enron's Zero Notes and 7% Notes to Silvercreek as a good investment. (Id. ¶¶ 677-80, 794-98.) Sara Randell, a Credit Suisse representative, approached Silvercreek in October 2001 with the “opportunity” to purchase the Zero Notes, representing them as an attractive investment. (Id. ¶ 678.) Silvercreek claims that it had numerous conversations with Randell, Credit Suisse's convertible bond desk, and the firm's research analysts (including Rick Vossler and Charles Guggenheim), and that it reviewed detailed forecasts, analyst reports (dated October 16, 19, 22, 23, 24, and 26; authored by Jill Sakol Curt Launder, Phillip Salles, Andy De Vries, Charles Guggeneim, and Rick Vossler, and others), and other business valuation materials provided by Credit Suisse. (Id. ¶¶ 640, 679, 682.) Silvercreek claims that Credit Suisse represented that the securities were an attractive investment opportunity, that Enron's accounting treatment was appropriate, and that its investment-grade credit rating was secure. (Id. ¶¶ 678-82.) Silvercreek purchased the Zero Notes and the 7% Notes from Credit Suisse in reliance, it alleges, on these representations. (Id.)

         Merrill Lynch also contacted Silvercreek in October 2001 about the opportunity to invest in the 7% Notes. (Id. ¶¶ 794-97.) Silvercreek claims that it had several conversations with Merrill Lynch brokers (including Haig Altoonian, Mike Nahill, and Terry O'Connor) and research analysts in connection with its decision to purchase the securities. (Id.) Merrill Lynch similarly provided Silvercreek with models and forecasts, analyst reports, and a proprietary investment tool. (Id.) Silvercreek claims that it read and relied upon Merrill Lynch's October 24, 2001 research report, which deemed it “unlikely” that Enron's credit rating would fall below investment grade. (Id. ¶ 796.)

         Silvercreek alleges that, in providing their recommendations to buy the Enron securities, Credit Suisse and Merrill Lynch failed to disclose material information about Enron's financial health: namely, that its financial statements overstated earnings and cash flow and understated debt, and that they played a role in facilitating Enron's accounting schemes. (Id. ¶¶ 681, 798, 853.) Silvercreek further claims that Credit Suisse and Merrill Lynch knew that Enron's reporting was fraudulent and misleading, and that they had incentives to promote Enron's securities in spite of their underlying weakness. (Id. ¶¶ 599-663, 798.)

         Merill Lynch and Credit Suisse move to dismiss. They argue that Silvercreek fails to identify misrepresentations with sufficient specificity to satisfy Rule 9(b), that Silvercreek fails to allege scienter, and that Silvercreek did not reasonably rely on the recommendations.

         The Court first addresses the element of scienter. Merrill Lynch and Credit Suisse argue that Silvercreek has not adequately alleged knowledge or intent on the part of any individual who encouraged them to purchase Enron securities or any author of any of the analyst reports in question. (Dkt. No. 50 at 10, 14.)

         To prove scienter, a plaintiff must ultimately show that a defendant had knowledge of the falsity of the statement and an intent to defraud. Crigger, 443 F.3d at 234. While knowledge and intent “may be alleged generally, ” under the pleading standard of Federal Rule of Civil Procedure 9(b), a court “must not mistake the relaxation of Rule 9(b)'s specificity requirement regarding condition of mind for a license to base claims of fraud on speculation and conclusory allegations.” Lerner v. Fleet Bank, N.A., 459 F.3d 273, 290 (2d Cir. 2006) (quoting Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995)).

         In order to survive a motion to dismiss under Rule 12(b)(6), “Plaintiffs must state facts sufficient to ‘give rise to a strong inference of fraudulent intent.'” Loreley Fin. (Jersey) No. 3 Ltd. v. Wells Fargo Sec., LLC, 797 F.3d 160, 176 (2d Cir. 2015) (quoting Lerner, 459 F.3d at 290). “An inference is ‘strong' if it is ‘cogent and at least as compelling as any opposing inference one could draw from the facts alleged.'” Id. at 176-77 (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 324 (2007)). “A fraud plaintiff may establish a ‘strong inference' of scienter, among other ways, ‘by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness.'” Id. at 177 (quoting Lerner, 459 F.3d at 290-91). In making this determination, the Court must “consider the complaint in its entirety and ‘take into account plausible opposing inferences.'” Stratte-McClure v. Morgan Stanley, 776 F.3d 94, 106 (2d Cir. 2015) (quoting Tellabs, 551 U.S. at 323).

         The Second Circuit stated the standard that applies to allegations of scienter against corporate defendants in Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190 (2d Cir. 2008):

When the defendant is a corporate entity, this means that the pleaded facts must create a strong inference that someone whose intent could be imputed to the corporation acted with the requisite scienter. In most cases, the most straightforward way to raise such an inference for a corporate defendant will be to plead it for an individual defendant. But it is possible to raise the required inference with regard to a corporate defendant without doing so with regard to a specific individual defendant.

Id. at 195. The Second Circuit has further clarified that for a corporate defendant “it is possible to plead corporate scienter by pleading facts sufficient to create a strong inference either (1) that ‘someone whose intent could be imputed to the corporation acted with the requisite scienter' or (2) that the statements ‘would have been approved by corporate officials sufficiently knowledgeable about the company to know' that those statements were misleading.” Loreley, 797 F.3d at 177 (quoting Teamsters Local, 531 F.3d 195-96).

         Silvercreek encourages the Court to adopt a broader approach to allegations of corporate scienter that disconnects the alleged misstatements at issue from the locus of knowledge of the misstatements' falsity, by imputing separate instances of specifically pleaded misstatements and knowledge to the corporation writ large.

         While Silvercreek is correct that “there is no requirement ‘that the same individual who made an alleged misstatement on behalf of a corporation personally possessed the required scienter, '” In re Marsh & Mclennan Companies, Inc. Sec. Litig., 501 F.Supp.2d 452, 481 (S.D.N.Y. 2006) (emphasis added) (quoting In re JP Morgan Chase Sec. Litig., 363 F.Supp.2d 595, 627 (S.D.N.Y. 2005)), [8] the facts alleged must nonetheless satisfy the requirement of Teamsters Local that “someone whose intent could be imputed to the corporation acted with the requisite scienter” or that the statements would have been approved by somebody with the requisite knowledge, Teamsters Local, 513 F.3d at 195. That is, under Second Circuit precedent, it is not enough to separately allege misstatements by some individuals and knowledge belonging to some others where there is no strong inference that, in fact, there was a connection between the two. The example cited in Teamsters Local describing a situation where a strong inference of scienter could be alleged independent of any individual allegations supports this nexus requirement:

[I]f General Motors announced that it had sold one million SUVs in 2006, and the actual number was zero . . . [t]here would be a strong inference of corporate scienter, since so dramatic an announcement would have been approved by corporate officials sufficiently knowledgeable about the company to know that the announcement was false.

Id. at 195-96 (quoting Makor Issues & Rights, Ltd. v. Tellabs, Inc., 513 F.3d 702, 710 (7th Cir. 2008)). This example makes clear the requirement of some connection at the corporation between a misstatement and the requisite quantum of knowledge of its falsity (in the example, by requiring someone with the required knowledge to approve the misstatement). This point is further underscored by the Teamsters Local court's insistence that any court finding a strong inference of corporate scienter from disconnected acts and knowledge is the exception rather than the rule.

         Considering the complaint in its entirety, the Court concludes that Silvercreek has not alleged circumstances that establish a strong inference of scienter on the part of Merrill Lynch or Credit Suisse.

         Silvercreek has alleged that there were individuals in both firms who were likely aware of Enron's financially manipulative transactions and, separately, that there were individuals who recommended that Silvercreek purchase Enron's securities (including research analysts who provided positive reports of Enron's financials). But, critically, Silvercreek has not alleged a connection between the recommendations and reports (the alleged misstatements) and the knowledge of their falsity sufficient to support a strong inference that the alleged misstatements themselves were made with an intent to defraud.

         Specifically, as regards the individuals who recommended Enron's securities to Silvercreek-Randell from Credit Suisse, and Altoonian, Nahill, and O'Connor from Merrill Lynch-the Complaint does not specifically allege that they were involved in or even aware of the deceptive financing techniques and accounting-driven transactions that the banks were elsewhere helping Enron to engage in. As a result, none of these individuals could have acted with the requisite scienter ...


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