Capital Markets

Partnership Liability: Enron’s Domino Effect

Limited partners in the special-purpose entities may have liability to both Enron and Enron shareholders, lawyer asserts.
Ronald FinkMarch 1, 2002

Most securities lawyers agree that investment banks that underwrote off-balance-sheet partnerships run by former Enron Corp. CFO Andrew Fastow bear a fiduciary responsibility to Enron shareholders. But the liability among Enron’s limited partners doesn’t end there, according to securities lawyer Stanley Grossman of Pomerantz, Haudek Block Grossman & Gross. Grossman, who is representing Enron lenders in a suit against underwriters of convertible bonds issued by the Houston energy company, contends that limited partners may have liability to both Enron and Enron shareholders.

To back up his claim, Grossman cites the Supreme Court case of Jackson v. Smith, as well as several recent lower-court decisions. A federal appeals court in 1977, for instance, ruled that “others who knowingly participate with a fiduciary in a breach of trust are liable to the beneficiary for any damage caused thereby.” That leads to Grossman’s view 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 with the Securities and Exchange Commission. Recall that last November, after Enron reduced shareholder equity by $1.2 billion and lowered its previously stated earnings for the years 1997 to 2001 by some $600 million, the SEC deemed that the debt-laden SPEs belonged on the energy trader’s balance sheet. The reworking 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 maintains, limited partners could share fiduciary liability with Fastow for Enron’s demise.

According to and other press reports, the list of limited partners in the SPEs includes AON, Credit Suisse First Boston, General Electric Capital, J.P. Morgan Capital, Lehman Brothers, Morgan Stanley, and Merrill Lynch. The Senate Governmental Affairs Committee is said to be looking into the role third-party investors played in Enron’s meltdown.

While some securities lawyers contend that limited partners will remain off the hook unless they helped promote the partnerships, securities attorney Stephan Haimo of Gibson, Dunn & Crutcher notes that “all kinds of legal theories” will be tested as a result of the Enron debacle.