U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 20225 / August 6, 2007
Accounting and Auditing Enforcement Release No. 2663 / August 6, 2007
SEC v. Jerry K. Castleman and Kathleen M. Lynn, Civil Action No. 06-3226 (Werlein) (S.D. Tex.)
SEC Settles Civil Fraud Charges Against Two Former Enron Executives
The Securities and Exchange Commission (Commission) announced today that on August 2, 2007, the U.S. District Court in Houston entered final judgments in the Commission's civil action against Jerry K. Castleman, a former Enron executive and accountant, and Kathleen M. Lynn, a former Enron executive.
In its complaint filed on October 13, 2006, the Commission alleged that Castleman, Lynn, and others participated in a transaction that defrauded Enron's security holders to enrich themselves and others. The complaint also alleged that the defendants' conduct involved both the closing of a sham sale pursuant to which Enron manufactured earnings, and the later unwinding of this sham sale by Enron repurchasing the asset without reversing the previously (and improperly) recognized earnings. The sham sale manipulated 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 alleged, 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. In addition, Enron paid LJM1 a profit, despite the poor economics of the project.
Castleman and Lynn each consented to the final judgments without admitting or denying the allegations in the Commission's complaint. They each agreed to be enjoined permanently from violating Section 17(a) of the Securities Act of 1933, Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 and Exchange Act Rules 10b-5 and 13b2-1, and from aiding and abetting violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and Exchange Act Rules 12b-20, 13a-1 and 13a-13. Castleman also agreed to be enjoined permanently from violating Exchange Act Rule13b2-2. Lynn's judgment orders her to pay nominal disgorgement of $1 and a civil penalty of $30,000. Castleman's judgment orders him to pay $41,268.29, consisting of disgorgement of $30,000 and prejudgment interest of $11,268.29, with all but $12,000 waived, based upon Castleman's sworn financial statements and other documents submitted to the Commission. 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.
In settlement of this action, Castleman also consented to the entry of an Administrative Order, pursuant to Rule 102(e) of the Commission's Rules of Practice, suspending him from appearing or practicing before the Commission as an accountant, with a right to apply for reinstatement after five years.
For additional information see Litigation Release No. 19865, October 13, 2006.