Enron Corp. - University of California | Office of The President

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earnings and separately disclosed in the footnotes. Mark-to-market accounting was used by Enron to recognize the present value of a five-year contract as earnings in a single quarter. Mark-to-market accounting is allowed only where contract revenue streams are predictable and based on historical records of similar transactions. However, the Enron Defendants knew there was no historical track record for many of the transactions to which Enron applied mark-to-market accounting. 535. For example, Enron improperly stretched mark-to-market past the limit by inappropriately applying it to transactions like broadband transactions and its retail/commercial energy demand-side management ("DSM") contracts. DSM contracts bundled various energy-related products and services to customers, including providing power and equipment commodities, and management and consulting services related to a customer's usage of power. While mark-to-market accounting is appropriate under certain circumstances for long-term contracts where the resulting revenue over time is predictable based on a historical record of similar transactions, as in straight commodity transactions such as oil and gas, it was not appropriate for Enron's DSM and broadband contracts. Mark-to-market accounting was inappropriate as no historical track record existed for these deals from which the Company could determine how much of the contract revenue was likely to be recovered over the life of the contract, and the contracts were highly speculative, with indeterminate outcomes. Accordingly, it was unreasonable to book significant amounts of the revenue up-front rather than over time. Additionally, mark-to-market accounting of Enron's DSM contracts was improper because most of the expected revenues were attributable to long-term services to be provided by Enron (normally booked over time, using the accrual accounting method), with only a small portion attributable to the commodity components for which mark-to-market rules could potentially apply. - 366 -
536. Because the use of mark-to-market accounting requires the ability to make reasonable estimates of future income streams, longer term contracts such as Enron's introduced more uncertainty into the estimate. The Enron Defendants improperly took full advantage of the fact that contracts that exceed four years could result in a wide range of fair value estimates and thus provide Enron with wide leeway in estimating the value of the contract. The Enron Defendants recorded income from these contracts even though they realized that once the contracts began to be performed, many would become losses because the cost, price and other assumptions were never valid to begin with. To avoid recording losses when it started to look like a deal was about to unfold, Enron would shift the curves – changed the estimate – to compensate for the anticipated loss, further misleading the shareholders. A former employee noted, "shifting the curve and making new deals to bury the losses from the past is constantly the strategy." Another former trader stated: "It was very simple. You just tweaked the assumptions on different variables, which were changed to make the return higher." 537. When Enron employed mark-to-market accounting, the Company calculated a range of revenue and risk possibilities (i.e., a low revenue/low risk model, or a high revenue/high risk model). Enron consistently chose the high revenue/high risk model for nearly every deal, but because Enron moved debt, costs, losses, and liabilities off its balance sheet through SPEs, this accumulation of risk was not disclosed to investors. For example, a former trader in Enron Global Markets was directed by his boss in the 4thQ 00 to show an extra $2 million in trading revenues for the quarter. To do this, they just increased the amount of money on an already booked deal for oil to be delivered in the future using mark-to-market accounting. This was called "moving the curve." This was altering the assumptions used to estimate income on contracts accounted for under mark-to- market. Moving the curve projection just 1% could mean millions in extra income. This abusive - 367 -
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KEN L. HARRISON, STEVEN J. KEAN, RE
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TABLE OF CONTENTS - i - Page PREAMB
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... hiding losses/SEC violations)..
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2 Certain defendants named herein,
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to do so would incriminate them. Wh
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y Enron to keep high-debt assets li
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in JEDI, making it possible for tra
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continued to accelerate, ultimately
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financial condition and investment
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it controlled, and was doing phony
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Bobcat Raptor-IV Marlin Trust I Mar
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to be utilized to engage in transac
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facilitate and finance LJM2's illic
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unnoticed: 30. This blatant self-de
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LJM1 and LJM2 in transactions struc
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and more of the stock issuance "tri
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dollar contracts which allowed it t
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41. Just eight months after announc
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Dollars Per Share 30 25 20 15 10 5
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Enron's financial condition to make
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Enron's finances, but very likely w
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Merrill Lynch CitiGroup Banks Named
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CitiGroup Barclays Banks Named As D
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The employee adds that anyone who q
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of the SPEs Enron did business with
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destroying millions of pages of doc
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- Statement of Financial Accounting
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eporting earnings from the 3rdQ 00
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disclosures were crafted and approv
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falsify its financial results and t
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72. On 2/26/02, Dow Jones News Serv
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A. Lead Plaintiff PARTIES 79. Court
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(g) Plaintiff Amalgamated Bank, as
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D. Defendants and Related Parties (
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Enron Corp. Defendant J. Skilling's
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Dollars per Share Enron Corp. Defen
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Enron Corp. Defendant S. Horton's Q
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Ms. Olson [told] employees in Decem
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(dd) Defendants John Mendelsohn ("M
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(ii) The Marlin Water and Atlantic
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public information, pocketing over
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Dollars per Share $100 $80 $60 $40
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As of 3/98 Executive Committee Comp
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Steven J. KeanSenior Vice President
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Kevin P. Hannon Chief Operating Off
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shortly after their issuance and/or
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(b) Defendant Thomas H. Bauer ("Bau
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(l) Defendant Richard R. Petersen (
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(4) Investment Banks 99.1 Each of t
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Notes due 7/15/06 and 6.95% Notes d
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devised, implemented and financed (
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6.19% Senior Secured Notes due 03;
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of and controlled by Bank of Americ
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fraudulent scheme by disguising deb
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fraudulent scheme by repeatedly iss
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BACKGROUND TO THE CLASS PERIOD 109.
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"Enron's water subsidiary initially
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• Enron just had a great, great q
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loans to the SPEs and Barclays had
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without any adequate feasibility st
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Registration Statement was signed b
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• Wholesale Energy Operations and
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... Together, our business units re
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10-K report. The Form 10-K containe
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performance and all of the indicati
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150. On 5/7/99, Lehman Brothers iss
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Communications Is Running Faster an
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costs. For example, Enron picked th
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(k) Under Mark-Jusbasche, Enron Int
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(p) As a result of the foregoing, t
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160. On 7/14/99, The Houston Chroni
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In discussing the most recent decli
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• Enron expects this sector ... t
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178. On 10/12/99, Bloomberg reporte
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three times the $850 million contra
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Enron Corp. had a 12.5% increase in
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months there was speculation of a c
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* * * ECI has two new and related b
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198. On 1/18/00, CS First Boston is
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• This is a huge step forward for
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208. On 1/21/00, Merrill Lynch issu
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The company hopes to capture 10 per
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of mark-to-market accounting by ado
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(ii) EES entered into demand-side-m
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(j) To inflate the purported revenu
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(q) As a result of the foregoing, t
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Andersen: 218. With respect to EES,
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Fastow also appeared at the Enron A
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227. On 4/12/00, CitiGroup issued a
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communications segment. The wholesa
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TRADING GROWING FASTER THAN EXPECTE
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Enron and Blockbuster plan to intro
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• The bandwidth trading component
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Broadband Services In our view, Enr
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• ENE reported 2Q00 EPS of $0.34,
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• ... Enron Broadband Services ..
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• In terms of content, Enron Broa
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It also had over 10 additional tran
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• Impressive wholesale energy res
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271. As a result of defendants' fal
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let alone continue to engage in sim
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Retail Energy Services: ... Enron E
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Well, we were up, 1998, we were up,
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• Growth Targets Lifted .... * *
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acceleration of growth and creation
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Our talented people ... financial s
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stock, selling 1.1 million shares i
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evenue. Even though Enron could not
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ecognized a multi-million dollar pr
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exchange for orders by Enron in 99
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streaming content because the EIN a
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not have the legal right to electro
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illions of dollars while concealing
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4 years .... We are projecting mini
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and Content Delivery which remain s
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• a 281 percent increase in reven
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[W]e ... said to investors, as long
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growth in '98, 18% growth in '99 an
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conference calls and in follow-up c
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stated: 332. On 7/12/01, Skilling a
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337. On 7/25/01, Bloomberg News rep
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financial condition and liquidity -
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equipment, a significant portion of
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million up-front cash just to sign
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(i) Enron entered into dark-fiber s
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intermediation. Even worse, Enron g
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sense, to "just drink more Enron Ko
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Dear Mr. Lay, * * * Skilling's abru
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. Cliff Baxter complained mightily
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is up 40%, earnings per share up ab
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CEO Jeff Skilling Resigns; A Negati
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356. On 8/28/01, Lay was interviewe
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... But all of the problems I have
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362. On 10/9/01, Merrill Lynch issu
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- $180 million associated with the
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income, to about $400 million and a
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Enron Corporation (BUY) Third Quart
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of things - the LJM transactions we
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Enron Continues As Market-Maker of
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failing to eliminate additional hun
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391. Rubin's and Harrison's effort
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DEFENDANTS' SCHEME AND FRAUDULENT C
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Enron Defendants had permitted Enro
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Derrick 230,660 $ 12,563,928 John D
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Dollars per Share $100 $80 $60 $40
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Page 324 and 325: ENRON'S FALSE FINANCIAL STATEMENTS
Page 326 and 327: $12,000,000,000 $10,000,000,000 $8,
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Page 330 and 331: 8 Debt to equity is calculated usin
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Page 340 and 341: (2) LJM Partnerships 448. Enron als
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Page 344 and 345: CS First Boston, Merrill Lynch, JP
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Page 348 and 349: gathering system in the Gulf of Mex
Page 350 and 351: (b) Raptors (i) Raptor I 477. The f
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Page 354 and 355: million, giving LJM2 its specified
Page 356 and 357: y a total of $1 billion in the unau
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Page 360 and 361: (2) the transferred assets were not
Page 362 and 363: S-K required the disclosure of the
Page 364 and 365: Even though a misstatement of an in
Page 366 and 367: 522. In order for Enron to accrue r
Page 368 and 369: engaged in swapping capacity of thi
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Page 374 and 375: What made it all work, Dickson said
Page 376 and 377: 14 Securities that are bought and h
Page 378 and 379: (4) Quaker Oats 557. Under one of i
Page 380 and 381: supplied by Enron under the terms o
Page 382 and 383: (2) Prepaid Swaps with CitiGroup an
Page 384 and 385: In essence, his report concluded, E
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Page 388 and 389: earnings below expectations. By 97,
Page 390 and 391: content services business. In fact,
Page 392 and 393: 593. Enron also failed to disclose
Page 394 and 395: Enron arrived in India in the early
Page 396 and 397: holdings for $700 million. It is no
Page 398 and 399: investment and credit decisions ref
Page 400 and 401: Date of Offering Effective Date of
Page 402 and 403: created in Enron, the Offering Docu
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Page 406 and 407: FINANCIAL RISK MANAGEMENT * * * Enr
Page 408 and 409: Vinson & Elkins also knew because t
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Page 412 and 413: not even make a broadband connectio
Page 414 and 415: 05/17/01 Enron Euro Credit Linked N
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Communications Enron is developing
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(a) Annual Report on Form 10-K for
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ENRON HISTORICAL CONSOLIDATED FINAN
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Business of Enron DESCRIPTION OF EN
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Income Statement Data: SELECTED HIS
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• the transportation of natural g
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Balance Sheet Data (at end of perio
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wholesale customers to view Enron's
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ENRON HISTORICAL CONSOLIDATED FINAN
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Marlin Water Trust II/Marlin Water
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Retail Energy Services Enron Energy
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Cumulative effect of accounting cha
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A. General INVOLVEMENT OF THE BANKS
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manage such conflicts of interests.
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privately held entity created by En
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caused its stock to plunge and impa
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its financial results. Thus, the ba
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something each of the banks named a
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7/01 Marlin Water Trust II, Marlin
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default puts" on Enron's publicly t
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were fraudulent and used to conceal
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667. These phony commodity transact
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anging falsification of its financi
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DATE SECURITY 11/93 8 million share
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8/01 $3 billion Enron credit facili
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a year in interest payments, and sy
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participation in the scheme to defr
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illicit partnerships or SPEs, and h
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698. In 6/99, CS First Boston acted
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703. In addition to the foregoing,
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These transactions included Marlin,
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of the firm, invested $22.5 million
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the CIBC legal entity, as its knowl
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sales where CIBC was one of the und
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not a true investor and was not at
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"It was nothing but a pilot project
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Tilney's wife was a Managing Direct
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otherwise to outside investors'" an
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an effort spearheaded by Schuyler M
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Barry S. Friedberg, $500,000 Chairm
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Flash Report" for 12/23/99 identifi
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• Currently pitching to become En
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Concurrently, Enron advised Merrill
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742.19 Internally, Merrill Lynch co
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if Enron defaulted within a given t
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748. By the beginning of the Class
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- something that Barclays was in a
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length transactions with to generat
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Brothers legal entity, as its knowl
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5/99 $500 million 7-3/8% Enron note
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financial information as Enron's le
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instance: 5/00 $500 million 8.375%
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and condition of Enron's business o
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eturn for Deutsche Bank's participa
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DATE TRANSACTION 7/98 $252 million
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797. Deutsche Bank also actively en
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would pay it a large fee for the ea
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797.8 The Washington Post further f
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797.12 Bankers Trust's role in Proj
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797.17 In the words of the Joint Co
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797.25 Project Tomas was structured
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emaining from Bankers Trust to Enro
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INVOLVEMENT OF VINSON & ELKINS 800.
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accommodated Enron's desire for one
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The document ... sharply criticizes
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to "close," i.e., take place, and t
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806. However, Enron could not find
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810. During 12/97, Vinson & Elkins
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day-to-day activities would be mana
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equired to pay Enron on the "hedge"
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these SPEs, Enron would have to tak
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Vinson & Elkins Concealed the Phony
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In March 2001, Enron acquired the l
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ecause it participated in the negot
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839. The related-party disclosures
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846. The "disclosures" above are fa
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The Attempted Coverup 850. In mid-8
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3. There is a veil of secrecy aroun
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854. The result of this letter - la
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standpoint. In this regard, AA cons
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A. General INVOLVEMENT OF ARTHUR AN
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Andersen also consented to the use
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905. Andersen's reports were false
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investors that would hold assets an
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915. Andersen also performed certai
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ing to light documents illustrating
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he was aware of many of the company
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Andersen employees destroyed incrim
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departments, knew about the excessi
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a blind eye to the numerous red fla
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• How Enron could, with its own c
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Tallying all expected profits immed
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c. Determine whether the transactio
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keep the Chewco deal off the books.
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improper accounting was corrected).
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in order for the financial statemen
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959. As detailed herein, Enron's di
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connection with an SEC investigatio
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eached by David Duncan and other ac
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. Fails to correct an entity's fina
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(j) The fourth standard of reportin
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Professional Standards Group has fi
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headquarters are located at 33 West
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STATUTORY SAFE HARBOR 985. The stat
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988. Plaintiffs' claims are typical
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- 628 - Michael M. Lowther* Benjami
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1000. This Claim is brought by the
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Type of Offering Enron Corp. 7.875%
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day of the offering. day of the off
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liable as detailed herein. Defendan
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08/17/00 Enron Credit Linked Notes
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subdivisions thereof and/or State P
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JP Morgan and Lehman Brothers had a
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1016.26 This Claim is brought pursu
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Plaintiffs hereby demand a trial by
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SHAPIRO HABER & URMY LLP THOMAS G.
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