U.S. Securities and Exchange Commission
Litigation Release No. 18776 / July 8, 2004
Accounting and Auditing Enforcement Release No. 2051 / July 8, 2004
Securities and Exchange Commission v. Richard A. Causey, Jeffrey K. Skilling and Kenneth L. Lay, Civil Action No. H-04-0284 (Harmon) (S.D. Tx.) (July 8, 2004) (Second Amended Complaint)
SEC CHARGES KENNETH L. LAY, ENRON'S FORMER CHAIRMAN AND CHIEF EXECUTIVE OFFICER, WITH FRAUD AND INSIDER TRADING
Complaint Alleges Participation in Scheme to Defraud with Skilling, Causey and Others; Seeks Civil Penalty and Recovery of Over $90 Million In Unlawful Proceeds from Stock Sales
The Securities and Exchange Commission ("Commission") today initiated civil charges against Kenneth L. Lay, former Chairman and Chief Executive Officer of Enron Corp., for violating, and aiding and abetting violations of, the antifraud, periodic reporting, books and records, and internal controls provisions of the federal securities laws. [Section 17(a) of the Securities Act of 1933 ("Securities Act") and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), and Exchange Act Rule 10b-5, and for aiding and abetting the violation of Sections 13(a), and 13(b)(2)(A) and (B) of the Exchange Act, and Exchange Act Rules 12b-20 and 13a-11]. In this action, the Commission is seeking disgorgement of all ill-gotten gains, civil money penalties, a permanent bar from acting as a director or officer of a publicly held company, and an injunction against future violations of the federal securities laws.
The Commission today, subject to the approval of the Honorable Melinda Harman, U.S. District Court Judge, filed a Second Amended Complaint seeking to add Lay to its pending action against Jeffrey K. Skilling, Enron's former President, CEO and Chief Operating Officer, and Richard A. Causey, Enron's former Chief Accounting Officer. The proposed Second Amended Complaint alleges that Lay and others engaged in a wide-ranging scheme to defraud by falsifying Enron's publicly reported financial results and making false and misleading public representations about Enron's business performance and financial condition. In addition, the proposed Second Amended Complaint alleges that Lay profited from the scheme to defraud by selling large amounts of Enron stock at prices that did not reflect its true value. The sales also occurred while Lay was in possession of material non-public information concerning Enron and generated unlawful proceeds in excess of $90 million during 2001. Specifically, Lay sold over $70 million in Enron stock back to the company to repay cash advances on an unsecured Enron line of credit. In addition, while in possession of material non-public information, Lay amended two program trading plans to enable him to sell an additional $20 million in Enron stock in the open market. Lay's proceeds from the sales constitute illegal gains resulting from his scheme to defraud.
Specifically, the Commission's Proposed Second Amended Complaint alleges as follows:
Lay's Early Participation in the Scheme to Defraud. Lay, along with others at Enron, engaged in a wide-ranging scheme to defraud in violation of the federal securities laws. During 2001, with specific knowledge of rapidly deteriorating performances of Enron's business units, Lay made numerous false and misleading public statements about Enron's financial condition. As Enron's Chairman and CEO, Lay had oversight of Enron's business units and supervised the senior executives and managers of these units, reviewed drafts of public filings and draft press releases, and participated in conference calls with investment analysts.
In presentations to the investing public, Lay and others heavily emphasized the performance and potential of Enron Broadband Services (EBS) and Enron Energy Services (EES). To support what Enron had already said about EES, Lay and others concealed massive losses in EES' business through fraudulently manipulating Enron's "business segment reporting." They accomplished this at the close of the first quarter of 2001 through a reorganization designed to conceal the magnitude of EES' business failure, which was known to Lay as early as January 2001. With Lay's approval, Enron hid that failure from the investing public by moving large portions of EES' business - which Lay and others knew at the time would have to otherwise report hundreds of millions of dollars in losses - into Enron Wholesale, which was the Enron business segment housing most of the company's wholesale energy trading operations and income. As Lay and others knew, Enron Wholesale had ample earnings to absorb the EES losses, while at the same time continuing to meet its own internal budget targets. Lay made the false and misleading statements to persuade investors that Enron's profitability would continue to grow, to maintain credit ratings, to influence investment analysts, and to prop up the share price of Enron stock.
Lay knew of Enron's use of structured transactions - specifically prepays and the infamous Raptors - to misstate its financial results. Enron entered into circular transactions that were characterized as prepay forward contracts in order to disguise borrowings as cash from operations. Lay was aware of the importance and magnitude of prepay transactions to create operating cash flow and thereby maintain Enron's investment grade credit rating. Lay was aware that the credit rating agencies were not told the magnitude of Enron's prepay obligations and that this information was not disclosed in Enron's public filings. In addition, Enron created the Raptor structures to "hedge" volatile assets against any potential decline in value. The manner in which Enron structured and funded the Raptors meant that any hedging losses in the Raptors would ultimately be borne by Enron. Lay understood that Enron used the Raptors for earnings management and that decreases in the price of Enron stock threatened the viability of the Raptors.
Lay Knowledge of Additional Problems Following Skilling's Resignation. On July 13, 2001, Skilling unexpectedly told Lay he was resigning because he felt there was nothing he could do to stop the decline in Enron's stock price. On August 14, Enron issued a press release, with Lay's approval, that announced Skilling had resigned for personal reasons. In a conference call with investment analysts later that same day, Lay repeatedly asserted that, "there are absolutely no problems that had anything to do with Jeff's departure . . . there are no accounting issues, no trading issues, no reserve issues . . . unknown, previously unknown problems, issues . . . I can honestly say that the company is probably in the strongest and best shape . . . that it's probably ever been in." Regarding EES, Lay offered that "we've been doubling revenue and doubling income quarter on quarter, year on year for now about the last three years. We expect that to continue to grow very, very strong. . . ."
After Skilling resigned, Lay met repeatedly with Enron's senior management, who described for him Enron's deteriorating financial condition. Lay was advised internally of accounting improprieties regarding the Raptors and that various assets and investments were overvalued on Enron's books and records by approximately $7 billion. During this period, Lay repeatedly received internal financial reports consistent with these problems. In August and September, senior executives informed Lay that Enron was facing an increasing earnings shortfall, hundreds of millions of dollars in losses, a proposed non-recurring charge relating to certain investments, and an accounting error in excess of $1 billion. Enron's problems were so severe that a senior executive informed Lay that Enron needed to consider being acquired or selling its prized pipelines.
Lay Continued to Mislead the Public - August and September 2001. Despite specific knowledge of Enron's deteriorating financial condition, Lay continued to make false and misleading public statements about Enron's financial performance. In meetings with research analysts and in public statements, Lay falsely and misleadingly stated there were "no accounting issues," "no reserve issues," and "no other shoes to fall" at Enron. Lay made a series of false and misleading statements during an Enron employee online forum, including that: "[t]he third quarter is looking great. We will hit our numbers. We are continuing to have strong growth in our businesses," "we have record operating and financial results," and "the balance sheet is strong." In addition, Lay misled Enron employees regarding his purchases of Enron stock when he informed them that he had purchased additional shares over the last couple of months. In making this statement, Lay concealed that he had made net sales of over $20 million in Enron stock in the preceding two months.
The October 16, 2001 Third Quarter Earnings Release. In a meeting with other senior executives one month prior to Enron's third quarter earnings release, Lay learned that Enron had incorrectly accounted for the Raptor transactions, and as a result, Enron shareholders' equity would be reduced by $1.2 billion. Lay also knew that the Raptors were being terminated and combined with other pending write-downs that would result in an earnings charge of $1.01 billion. Specifically, Lay knew that these two items - the $1.01 billion earnings charge and the $1.2 billion reduction of shareholder equity - were unrelated, and that the reduction to shareholders' equity was required whether or not the Raptors were terminated. Lay reviewed and approved Enron's earnings release that reported a "nonrecurring" earnings charge of $1.01 billion, a majority of the charge ($544 million) relating to the early termination of the Raptors. Lay knew that the characterization of the termination of the Raptors as "nonrecurring" losses was erroneous and inconsistent both with advice Enron had received from its auditor and Enron's past treatment of Raptor earnings as recurring operating earnings. Lay and others intentionally omitted any reference to the $1.2 billion equity reduction from the press release. In a conference call with analysts to discuss the earnings release, Lay falsely stated that "in connection with the early termination" of the Raptors, Enron's shareholders' equity would be reduced by $1.2 billion. Lay did not disclose, as he knew, that the reduction was principally due to a significant accounting error, as opposed to the termination of the Raptors.
Lay's Last Ditch Efforts -- October and November 2001. In an effort to calm deepening public concern regarding the decline in Enron's stock price, Lay participated in conference calls with analysts and others. In these calls, Lay made false and misleading statements regarding Enron's financial health. For example, Lay stated, "[Enron is] not trying to conceal anything. We're not hiding anything," and "[w]e're really trying to make sure that the analysts and the shareholders and the debt holders really know what's going on here. So, we are not trying to hold anything back." In a telephone call with a prominent credit rating agency, Lay falsely stated that Enron and its auditors had "scrubbed" the company's books and that no additional write-downs would be forthcoming. In fact, Lay knew that Enron was carrying its international assets at billions in excess of their fair value and that Enron had failed to disclose a $700 million goodwill impairment. In an all-employee meeting to reassure Enron's employees, Lay falsely described Enron's liquidity, stating that "[o]ur liquidity is fine. As a matter of fact, it's better than fine, it's strong. . ." At the time he made the statement, Lay knew that Enron had been forced to offer its prized pipelines as collateral for a $1 billion bank loan and that the only source of liquidity was a $3 billion line of credit, which was fully utilized on Lay's authority. In addition, Lay made misleading statements about Enron stock and its prospects. Lay misleadingly stated, "as sad as the current market price is . . . [b]ut we're going to get it back" and "that doesn't mean we can't get back up to the $80s or $90s in the not-too-distant future." At the time he made the statement, with Enron stock trading at less than $20 per share, Lay did not disclose that he had quietly sold over $65 million of Enron stock back to the company during 2001.
Lay's Sales of Enron Stock Back to Enron. From January 25, 2001 to November 27, 2001, Lay took advances on a non-collateralized $4 million line of credit with Enron in the total amount of $77,525,000. Thereafter, in twenty separate transactions, Lay repaid the credit line by selling $70,104,762 worth of Enron stock back to the company, at prices he knew did not accurately reflect Enron's true financial condition. For example, after learning of Enron's undisclosed plan to hide over $500 million in EES losses in ENA, Lay sold 1,086,571 shares of Enron common stock back to the company, in 11 transactions, for a total of $34,081,558. Following Skilling's resignation on August 14, 2001, at a point when Lay was learning more about Enron's deteriorating financial condition, Lay sold 918,104 shares of Enron common stock back to the company, in five transactions, totaling $26,066,474. As Lay tried to prop up Enron's stock price following Enron's third quarter earnings release on October 16, 2001, Lay sold 362,051 shares of Enron stock back to the company, in four transactions, totaling $6,050,232. Enron's shareholders and employees, much less the public, did not learn of Lay's sales of Enron stock back to the company until February 2002, over two months after Enron filed for bankruptcy protection.
Lay also made withdrawals from his line of credit totaling $7.5 million between October 24 and November 27, 2001, at a point when Enron's financial condition was crumbling.
Lay's Sales of Enron Stock Pursuant to Amended 10b5-1 Plans. On November 1, 2000, Lay established two program sales plans under Commission Rule 10b5-1. Subsequently, Lay amended both plans. At the time Lay amended both plans, he was in possession of material nonpublic information concerning Enron's deteriorating financial condition, meaning Lay cannot use the plans as a defense to insider trading charges. Under the amended plans, Lay unlawfully sold over 350,000 Enron shares for total proceeds in excess of $20 million.
The Commission acknowledges the assistance of the Enron Task Force.
The Commission's investigation is continuing.
SEC Complaint in this matter