U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19865 / October 13, 2006
Accounting and Auditing Enforcement
Release No. 2492 / October 13, 2006
Securities and Exchange Commission v. Jerry K. Castleman, Cheryl I. Lipshutz, and Kathleen M. Lynn, Civil Action No. 06-3226 (SDTX) (October 12, 2006)
SEC Charges Three Former Enron Employees with Violating the Federal Securities Laws
Cheryl I. Lipshutz, Former Enron Vice President, Simultaneously Settles Charges
On October 12, the Securities and Exchange Commission charged Jerry Kent Castleman, former Enron executive and accountant, and Cheryl I. Lipshutz and Kathleen M. Lynn, former Enron executives, with violating the antifraud provisions of the federal securities laws and aiding and abetting Enron's violations of the reporting, record-keeping and internal controls provisions. As alleged in the Commission's complaint, Castleman, Lynn and Lipshutz, along with others, engaged in a fraudulent transaction to manipulate Enron's publicly-reported earnings, which resulted in Enron filing materially false and misleading financial statements in the company's annual report on Form 10-K for the fiscal years ended December 31, 1999 and 2000, and in the company's quarterly reports on Form 10-Q for the third quarter of fiscal year 1999, the first three quarters of fiscal year 2000, and the first two quarters of fiscal year 2001.
Specifically, the Commission's complaint alleges, among other things, that Enron sold an interest in a troubled power project in Cuiaba, Brazil to a related party called LJM Cayman, LP (LJM1), controlled by Enron's then Chief Financial Officer, Andrew Fastow (the "selldown"). Through the selldown, Enron South America (ESA), an Enron subsidiary, deconsolidated its interest in the project and Enron recognized earnings from related gas supply contracts. Enron and ESA needed these earnings to meet earnings estimates for the third and fourth quarters of 1999. In conformity with relevant accounting rules, deconsolidation and recognition were not appropriate because the seller (Enron) did not transfer to the buyer (LJM1) the usual risks and rewards of ownership, in that the selldown included an oral side agreement that LJM1 would not lose money on its Cuiaba investment (the "side agreement"). The side agreement was neither memorialized in the deal documents nor disclosed to Enron's auditor. In 2001, to satisfy the side agreement, Enron bought back LJM1's interest without reversing the previously (and improperly) recognized earnings (the "buyback"). In addition, Enron paid LJM1 a profit despite the poor economics of the project.
As alleged in the complaint, Castleman and Lipshutz negotiated and documented the selldown, and Castleman and Lynn negotiated and documented the buyback. The complaint alleges that the defendants knew or were reckless in not knowing of the existence of the side agreement and that it was not included in the deal documents. They also knew, according to the complaint, that the Cuiaba project was troubled and that Enron was incurring significant costs to keep it going. The complaint alleges that the defendants knew or were reckless in not knowing that the purpose of the selldown was to improperly deconsolidate the project and manufacture earnings from related gas supply contracts. In early drafts of the deal documents, rejected by Enron's independent auditor, Castleman and Lipshutz attempted to structure the selldown so that LJM1 would assume no transactional risk. Castleman and Lynn negotiated and documented the buyback in which Enron paid LJM1 a profit of over 13% for temporarily parking the interest, even though the value of the interest had decreased significantly over time due to the problems with the project. The complaint alleges that Castleman, Lipshutz and Lynn knew or were reckless in not knowing that the side agreement violated Enron's desired accounting treatment. According to the complaint, Castleman also concealed the undocumented side agreement from Enron's independent auditor and knew that Enron did not reverse the previously (and improperly) recognized earnings at the time of the repurchase.
The complaint further alleges that by engaging in the above-described conduct, Castleman, Lynn and Lipshutz violated Section 17(a) of the Securities Act of 1933, Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 10b-5 and Rule 13b2-1 thereunder, and aided and abetted Enron's violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder. In addition, the complaint alleges that Castleman violated Rule 13b2-2 of the Exchange Act. The complaint seeks permanent injunctions, disgorgement with prejudgment interest and penalties from each of the defendants, as well as an order barring Castleman from serving as an officer or director of a publicly-traded company.
Simultaneously with the filing of the complaint, Lipshutz, without admitting or denying the Commission's allegations, consented to the entry of a final judgment that permanently enjoins her from violating the identified provisions, and orders her to pay disgorgement of $20,000, prejudgment interest of $7,150 and a penalty of $25,000. The Commission intends to have the disgorgement and civil penalty amounts paid into a court account pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002 for ultimate distribution to victims of the fraud.
The Commission's investigation is continuing.
SEC Complaint in this matter