Capital Markets

Partners to the End?

Attorney argues that limited partners in Enron's special purpose entities had fiduciary responsibilities, too. But exactly who were those partners?
Marie Leone and Ronald FinkJanuary 28, 2002

Outside investors in off-balance-sheet partnerships run by former Enron CFO Andrew Fastow may share his fiduciary liability for the energy trading company’s demise. At least, that’s the charge now being leveled by a securities lawyer involved in a lawsuit against Enron.

Stanley Grossman, an attorney at law firm Pomerantz, Haudek, Block, Grossman & Gross, is representing Enron lenders in a suit aimed at the underwriters of an exchangeable note issued by the Houston energy company in January 1999. Nevertheless, Grossman contends that outside investors in the partnerships may bear no less fiduciary responsibility for Enron’s meltdown than Fastow.

To back up his claim, Grossman cites the case of Jackson v. Smith, heard by the U.S. Supreme Court, as well as several recent lower court decisions. Grossman insists that both state and federal courts ruled that “others who knowingly participate with a fiduciary in a breach of trust are liable to the beneficiary for any damage caused thereby.” He adds that the courts held that limited partners are “equally culpable” with the general partner.

Three of the special purpose entities (SPEs) run by Fastow — LJM, Jedi and Chewco — hid Enron’s debt and inflated its income, according to information filed by Enron with the Securities and Exchange Commission. Among the limited partners in LJM: American International Group, AON, Citigroup, Canadian Imperial Bank Corp., Credit Suisse First Boston, Dresdner Bank, General Electric Capital, J.P. Morgan Chase, Lehman Brothers, Morgan Stanley, Merrill Lynch, and Wachovia Bank, according to a report by The site named several smaller institutional investors as well.

Meanwhile, has learned that Deutsche Bank was a limited partner in either LJM or Chewco. And Enron itself has disclosed that the powerful California Public Employees Retirement System (Calpers) was an investor in Jedi.

As you recall, last November 8, Enron reduced its shareholder equity by $1.2 billion. At the same time, the company lowered its previously stated earnings for the years 1997 to 2001 by some $600 million. The restatements came after the SEC deemed that Enron’s debt-laden special purpose entities belonged on the energy trader’s balance sheet. The stunning rejigging of Enron’s financials eventually led to the company’s bankruptcy, the largest in U.S. corporate history. As a result of their investments in the partnerships, Grossman contends that these third-party participants may share fiduciary liability with Fastow for Enron’s demise.

The Senate Governmental Affairs Committee’s Permanent Investigations Subcommittee is also said to be looking into the roles played by third-party investors. Until recently, the identity of most of those investors had pretty much been a mystery.

On the other hand, people who were asked to invest in Enron SPEs — but didn’t — have been none too shy about discussing Fastow’s pitch. In an article published by Bloomberg, Danny Bowers, chief investment officer of the Houston Firefighters Relief and Retirement Fund, said the Enron CFO approached him about sinking money into LJM2. Bowers says he declined because of Fastow’s dual role as Enron finance chief and general partner of LJM2. “There was a pretty blatant conflict of interest,” Bowers told Bloomberg. “It was kind of a stinky deal.”

According to the Bloomberg story Enron executives also tried to convince officials of the University of Texas endowment fund to invest in a number of the company’s off-balance-sheet partnerships. Officials at the fund declined the offers.

Not all public employee fund managers said no to Fastow, however. In an SEC filing, Enron disclosed that Calpers had been an investor in Jedi, but sold its interest in 1998. The filing also noted that Enron management believed that “a significant number of institutions and other investors that are not related parties” were partners in LJM. But the filing did not identify any of those investors, nor the outside partners in Chewco.

Draft Dodgers?

But a former Enron employee who claims to have helped prepare that SEC filing told that General Electric Capital Corp., Deutsche Bank, and Dresdner Bank had been identified in an early draft of the document. The source asserts that the names of those three investors were deleted from the version sent to the commission. That deletion, the ex-employee alleges, was made at the behest of William McLucas. McLucas, a former director of the SEC’s enforcement division, was hired by the Houston-based energy trader on October 31 to help an Enron special board committee comply with an inquiry launched by the commission into the company’s finances. McLucas is now a partner in the Washington, D.C., law firm of Wilmer, Cutler & Pickering. The former employee also claims to have received instructions to destroy the draft of the filing containing the names of the three companies.

McLucas did not return’s call on Friday, and no one from GE Cap, Deutsche Bank, or Dresdner Bank would comment about the case. A source close to Calpers, however, reportedly said the pension fund’s investment officers were not aware that Jedi was an affiliate of Enron, or that Fastow was involved.

Some attorneys point out that limited partners could not have knowingly violated their fiduciary responsibility to Enron’s investors — unless they knew a partnership was backed by Enron stock. But the fact is, the SPEs were evaluated by at least one rating agency, and according to an analyst at that agency, the rating specialist took the Enron collateral into account when assessing the partnership.

For his part, Grossman finds it hard to believe that Enron’s third-party investors weren’t aware of Fastow or Enron’s identity. In the case of LJM, Grossman notes, the limited partners had to qualify as sophisticated investors to be eligible to participate in private placements (under federal law, only qualified institutional investors can participate in certain types of private placements). Hence, Grossman argues, they had to know that Fastow was CFO of Enron. And, as qualified institutional buyers, they would be well aware that Fastow was in breach of his fiduciary responsibilities to Enron since he stood to benefit financially from these special purpose entities. Indeed, the Enron CFO ultimately earned more than $30 million from running the SPEs.

Grossman also argues the third-party investors could not have reasonably believed that Fastow could serve both Enron investors and the SPE investors equally well. In addition, he claims the partnership documents pointed out that the limited partners would benefit from Fastow’s position as Enron’s CFO.

Some attorneys contend, however, that limited partners in an off-balance-sheet partnership can’t be liable for fiduciary liability — unless they know that the partnership should have been consolidated. Even then, say these lawyers, the investors’ liability would be limited to their investment. In the case of the Fastow-led partnerships, those investments are likely vapor at this point. Grossman’s argument “sure sounds like a stretch to me,” says Steven Toll, a partner in the law firm of Cohen, Millstein.

But another securities lawyer, Stephan Haimo of Gibson, Dunn & Crutcher, notes that limited partners that exceed their role by acting as promoters of a partnership (or related partnerships) may open themselves up to liability beyond that of a limited partner. “You’d have to prove a vast conspiracy,” says Haimo, “and I don’t see it going that far, because you’re talking about bringing down the entire investment banking community.”

Of course, nobody thought one of the world’s largest and richest corporations would collapse almost overnight — and all due to a change in the company’s accounting practices. In the coming year, concedes Haimo, “we’ll be testing all kinds of legal theories.”