UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK In re: Chapter 11 ENRON CORP., et al., Case No. 01-16034 (AJG) Debtors. Jointly Administered FINAL REPORT OF NEAL BATSON, COURT-APPOINTED EXAMINER November 4,2003 TABLE OF CONTENTS I. INTRODUCTION .................................................................................................. 1 A. Background ................................................................................................. 1 B. Prior Reports ............................................................................................... 2 C. Summary of Conclusions. ........................................................................... 6 D. Standard Adopted by the Examiner .......................................................... 13 E. How to Read This Report ......................................................................... 14 I1. BACKGROUND .................................................................................................. 15 A. Events of Fall 2001 ................................................................................... 15 B. The Bankruptcy Filings and Subsequent Events ...................................... 17 I11. ROLES OF ENRON'S PROFESSIONALS, EXECUTIVE OFFICERS AND OUTSIDE DIRECTORS IN SPE TRANSACTIONS AND ................................................................................ THEORIES OF LIABILITY 18 A. Overview ................................................................................................... 18 B. Persons and Entities Involved in Enron's Use of SPEs ............................ 22 C. Theories of Potential Liability and Defenses ............................................2 3 IV. SPECIFIC ROLE OF ANDERSEN AND POTENTIAL LIABILITY ................ 39 A. Role of Andersen in Enron's SPE Transactions ....................................... 39 . . . B. Potential Liability ...................................................................................... 46 V. SPECIFIC ROLES OF ATTORNEYS AND POTENTIAL LIABILITY ........... 48 A. Overview ................................................................................................... 48 B. Outside Law Firms. ................................................................................... 48 C. Enron's In-House Attorneys ..................................................................... 52 VI. SPECIFIC ROLES OF LAY, SKILLING AND OUTSIDE DIRECTORS AND POTENTIAL LIABILITY. ......................................................................... 56 A. Roles of Lay, Skilling and Outside Directors in Enron's SPE Transactions .............................................................................................. 56 . . . B. Potential Liability ...................................................................................... 60 C. Lay's and Skilling's Use of Enron Stock to Repay Corporate Loans ....... 61 . VII ROLE OF FINANCIAL INSTITUTIONS IN ENRON'S SPE TRANSACTIONS AND THEORIES OF LIAl3ILITY ....................................... 63 A. Theories of Potential Liability .................................................................. 63 B. Potential Defenses to Aiding and Abetting Claims and Equitable . . Subordination ............................................................................................ 64 . VIII SPECIFIC ROLES OF FINANCIAL INSTITUTIONS AND POTENTIAL LIABILITY .................................................................................... 66 A. RBS ...........................................................................................................6 6 B. CSFB ......................................................................................................... 74 C. Toronto Dominion .................................................................................... 78 IX. HOW COULD THIS HAVE HAPPENED?. ........................................................ 82 A. Overview ................................................................................................... 82 B. Why Did Enron Officers Behave This Way? ........................................ 83 C. Methods Used by Officers to Implement Strategy ................................... 93 D. Failure of Professionals to Provide Checks and Balances ...................... 11 0 E. Failure of Lay and Skilling to Provide Checks and Balances ................. 11 7 F. Failure of Enron Board to Provide Checks and Balances ....................... 119 X. FINAL REPORT ................................................................................................ 13 7 Appendix A - Certain Defined Terms Appendix B - Role of Andersen Appendix C - Role of Enron's Attorneys Appendix D - Roles of Lay, Skilling and Outside Directors Appendix E - Role of RBS and its Affiliates Appendix F - Role of CSFB and its Affiliates Appendix G - Role of Toronto Dominion and its Affiliates I. INTRODUCTION A. Background On December 2,2001 (the "Petition Date") and on certain dates thereafter, Enron Corp. ("Enron"), an Oregon corporation, and certain of its affiliates (collectively, the "Debtors") filed voluntary petitions for relief under chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") with the United States Bankruptcy Court for the Southern District of New York (the "Court") (collectively, the "Bankruptcy case").' This Court entered an Order on April 8, 2002 (the "April 8thO rder") authorizing and directing the appointment of an examiner pursuant to 11 U.S.C. 8 1 104(c).~ On May 22, 2002, the United States Trustee appointed Neal Batson (the "Examiner") as the examiner. The Court, by Order dated May 24,2002, approved the appointment. The Examiner has been authorized to investigate all transactions involving special purpose vehicles created or structured by the Debtors or at the behest of the Debtors (the "SPEs") and those individuals, institutions and professionals involved therein.3 ' On July 11, 2003, the Debtors filed their Joint Plan of Affiliated Debtors Pursuant to Chapter 11 of the United States Bankruptcy Code. Docket Number 11698. On September 18, 2003, the Debtors filed their Amended Joint Plan of Affiliated Debtors Pursuant to Chapter 11 of the United States Bankruptcy Code (the "Debtors' Joint Plan"). Docket Number 12822. The hearing on the adequacy of the disclosure statement with respect to the Debtors' Joint Plan is presently scheduled for November 18,2003. Among other things, the April 8" Order authorized the Examiner to: investigate all transactions (as well as all entities as defined in the Bankruptcy Code and pre-petition professionals involved therein): (i) involving special purpose vehicles or entities created or structured by the Debtors or at the behest of the Debtors (the "SPEs"), that are (ii) not reflected on the Enron Corp. balance sheets, or that (iii) involve hedging using the Enron Corp. stock, or (iv) as to which the Enron Examiner has the reasonable belief are reflected, reported or omitted in the relevant entity's financial statements not in accordance with generally accepted accounting principles, or that (v) involve potential avoidance actions against any pre-petition insider or professional of the Debtors. The April 8" Order contained the provision that authorized the Examiner, if appropriate (taking into account the absolute priority rule, the financial condition of the Debtors' estates and the need not to waste value available to creditors), to review possible legal mechanisms pursuant to which the equity holders of Enron could share in the value of the Debtors' estates. There are legal mechanisms that could be used that On September 21, 2002, the Examiner filed the First Interim Report of Neal Batson, Court-Appointed Examiner (the "First Interim Report"). On January 21, 2003, the Examiner submitted to the Court the Second Interim Report of Neal Batson, Court- Appointed Examiner (the "Second Interim Report"). On June 30, 2003, the Examiner submitted to the Court the Third Interim Report of Neal Batson, Court-Appointed Examiner (the "Third Interim Report"; together with the First Interim Report and the Second Interim Report, the "Prior Reports"). This Final Report of Neal Batson, Court- Appointed Examiner, constitutes the Examiner's fourth and final report (the "Report"; together with the Prior Reports, the "~e~orts").~ B. Prior Reports Six SPE transactions were examined in the First Interim Report, and the Examiner concluded that the transactions were, to varying degrees, susceptible of being recharacterized under a "true sale" challenge. If this recharacterization were to occur, the remaining assets in those structures, having a value of approximately $500 million, would be restored to the Debtors' estates. would enable the equity holders to share in the value of the Debtors' estates, including plan provisions that provide that equity holders share in a portion of the proceeds of any allowed claim of any party-in-interest, including the Securities and Exchange Commission (the "SEC"). Based upon: (i) the status of ongoing negotations regarding the Debtors' Joint Plan; (ii) the information contained in the Debtors' amended schedules; (iii) the insolvency analysis undertaken by the Debtors and the Official Committee of Unsecured Creditors (the "Creditors' Committee"); (iv) the comments of the Court regarding the ability of the equity holders to recover in these cases based upon the apparent amount of claims in the cases; and (v) the desire not "to waste value available to creditors," the Examiner has not undertaken an extensive analysis of these legal mechanisms or their viability. 4 Any references in the Reports to meetings, communications, contacts and actions between the Examiner and third parties are intended to refer to the office of the Examiner, which shall include the Examiner and his professionals. Therefore, references to any meetings, communications, contacts and actions taking place between the Examiner and a third party should not be construed as indicating that Neal Batson was present personally for such meetings, communications, contacts or actions. The Second Interim Report focused on substantially all of Enron's material SPE transactions identified to date. The Examiner provided his views on the role of the SPEs in the collapse of Enron, including a discussion of how Enron used the SPEs in conjunction with six accounting techniques to impact dramatically its financial statements. The Examiner concluded that Enron manipulated its financial statements in violation of GAAP and failed to make appropriate disclosures of its SPE transactions to the public under applicable disclosure standards. Furthermore, the Second Interim Report sets forth the Examiner's conclusions that many of these transactions were, to varying degrees, susceptible of "true sale" or substantive consolidation challenges which, if successful, would result in assets having an estimated aggregate value between $1.7 billion and $2.1 billion being restored to the Debtors' estates. Finally, the Examiner identified potential avoidable transfers in the face amount of approximately $2.9 billion estate^.^ that may be recovered by the Debtors' 5 As noted in the Prior Reports, the ability of the Debtors to realize on certain of these avoidance actions is subject to: (i) affmative defenses of any transferee; (ii) valuation evidence (particularly in the case of constructively fraudulent transfers); and (iii) collectability. As to valuation, both the Debtors and the Creditors' Committee have engaged investment bankers or other valuation experts. In order to avoid duplication of effort, and because the Examiner does not have authority to prosecute actions on behalf of the Debtors' estates, the Examiner has not sought to retain such an expert. To the extent an action is pursued by the Debtors or the Creditors' Committee, investment bankers retained by such party may provide valuation advice. As set forth in the Prior Reports, the Examiner received assurances from the professionals for the Debtors and the Creditors' Committee to the effect that the Debtors, in coordination with the Creditors' Committee, would undertake to complete an insolvency analysis with respect to the Debtors. Accordingly, for the purposes of the Examiner's analysis of potential avoidance actions as well as for other purposes, the Examiner has assumed insolvency of the Debtors under Section 101(32) of the Bankruptcy Code at the time of any subject transfer. The professionals for the Debtors recently have advised the Examiner that the Debtors' professionals have concluded that Enron and certain of its Debtor affiliates were insolvent as of December 31, 1999, under the tests articulated under the Uniform Fraudulent Transfer Act andlor the Uniform Fraudulent Conveyance Act, as those acts may be applicable. Accordingly, and as discussed in the Prior Reports, there may be additional voidable transfer claims that may inure to the benefit of the Debtors' estates by virtue of the application of Section 544(a) of the Bankruptcy Code and the use of state law fraudulent transfer theories to challenge transfers made, or obligations incurred, more than one year prior to the Petition Date. The Examiner has been advised that the Debtors and the Creditors' Committee are investigating these claims. The Examiner also has been advised that the Debtors are investigating The primary focus of the Third Interim Report was on certain persons and entities that, under applicable legal standards, may have responsibility for the Debtors' misuse of its SPE structures. The Examiner concluded that there was sufficient evidence from which a fact-finder could conclude that certain senior officers of Enron, including Andrew Fastow (Tastow"), Rick Causey ("Causey"), Ben Glisan ("Glisan") and Jeff McMahon ("McMahon"), breached their fiduciary duties under applicable law by causing the Debtors to enter into SPE transactions that were designed to manipulate the Debtors' financial statements and that resulted in the dissemination of financial information known by these officers to be materially misleading. In addition, the Examiner concluded that there was sufficient evidence from which a fact-finder could conclude that certain financial institutions involved in Enron's SPE transactions: (i) aided and abetted these officers in breaching their fiduciary duties; and (ii) engaged in inequitable conduct such that a court could determine that the claims of such financial institutions, totaling in excess of $5 billion: should be equitably subordinated to the claims of other creditors. This would be in addition to any affirmative recovery that may be available to the possible avoidance actions arising out of Enron's equity forward transactions (as described in foonote 22 of the Third Interim Report). This amount could be significantly greater. As discussed in Appendix B (Legal Standards) to the Third Interim Report, published case law is unclear as to what happens if the "tainted" claim of a financial institution is purchased by another entity. That is, if a financial institution engaged in inequitable conduct such that equitable subordination was warranted, and if that financial institution then sold all or a portion of its claim (or syndicated a portion of the loan to other financial institutions after the closing of the transaction), would the claims of these purchasing financial institutions be subject to equitable subordination on the basis of the transferor's conduct? If the answer to that question is "yes," then an analysis of what claims, if any, were sold (or syndicated post-closing) by the financial institution that engaged in misconduct should be undertaken. The Examiner did not undertake this analysis given the expense involved and the uncertainty of the case law. This amount does, however, include the claims of certain entities (primarily trusts) that filed proofs of claim relating to or based on certain transactions in which a financial institution is the beneficial holder of the debt. Debtors against these financial institutions for aiding and abetting the officers' breach of fiduciary duty, assuming that the Debtors have the requisite standing to pursue such a claim.7 The Examiner also considered whether Section 548(a)(l)(A) of the Bankruptcy Code, which allows the avoidance of obligations and transfers made with the intent to hinder, delay or defraud creditors, could be applied to the Debtors' SPE transactions. If such a theory is applicable, and if a fact-finder determined that the Debtors entered into an SPE transaction with actual intent to hinder, delay or defraud its creditors, then the obligations incurred in that SPE transaction would be unenforceable. Either as a result of such a finding or if the fact-finder determined that the transfers made in connection with such SPE transactions were made with intent to hinder, delay or defraud, such transfers could be recovered by the Debtors' estates. Any transferee that entered into such an obligation or received such payments in good faith, however, would have a defense to this claim to the extent value was given to the ~ebtors.~ -- On September 24,2003, Enron and Enron North America Corp. (Wa Enron Capital & Trade Resources Corp.) ("ENA") filed the Debtors' Complaint for the Avoidance and Return of Preferential Payments and Fraudulent Transfers, Equitable Subordination, and Damages, Together With Objections and Counterclaims to Creditor Defendants' Claims with the Court against certain of these financial institutions and their affiliates. Enron Corp. v. Citigroup Znc., No. 03-09266 (AJG) (Bankr. S.D.N.Y. filed Sept. 24, 2003). In this complaint, the Debtors seek, among other things, to: (i) equitably subordinate the financial institutions' claims; (ii) recover in excess of $3 billion from these financial institutions as alleged avoidable transfers or obligations; and (iii) recover unstated damages resulting from alleged aiding and abetting on the part of these financial institutions. While the Examiner has not made a case-by-case analysis pursuant to this theory, there is sufficient evidence for a fact-finder to conclude that, with respect to Enron's overall use of SPEs, Enron entered into these transactions with the intent to hinder, delay or defraud its creditors. The Examiner also notes that the facts applicable to the potential claims of aiding and abetting a breach of fiduciary duty, or the potential equitable subordination of certain financial institutions' claims, are facts that would be relevant to the good faith defense. Finally, the Examiner identified additional potential avoidable transfers in the face amount of approximately $438 million that, to varying degrees, may be recovered by estate^.^ the Debtors' C. Summary of Conclusions Enron's officers, directors, accountants, attorneys and financial institutions had different roles and duties in the SPE transactions. As discussed in the Third Interim Report and in this Report, certain of these persons and entities may be liable to Enron or others for their roles in these transactions. Regardless of their respective legal liability, these parties are included within a circle of responsibility for Enron's financial demise. In the Third Interim Report, the Examiner reported on the role and potential liability of Enron's officers and certain financial institutions. The primary focus of this 9 The Examiner's analysis, for the most part, has not addressed the inter-estate avoidance action issues that may be implicated by the various SPE transactions discussed in the Reports. For example, in a number of transactions, ENA was the financial counterparty to an SPE, such as Delta or Mahonia - the SPEs used in certain of the Prepay Transactions. To the extent that ENA paid those obligations, and its obligations were guaranteed by Enron, ENA may be able to assert a preference claim against both the transferee (Delta or Mahonia) or against Enron under Sections 547 and 550 of the Bankruptcy Code. There also may be fraudulent transfer or obligation actions available to some estates against other estates by virtue of the SPE transactions. For example, as noted by the Examiner in the Third Interim Report, where ENA made certain payments in respect of the Mahonia transactions on behalf of its affiliate, ENG, the bankruptcy estate of ENA may be able to assert a fraudulent transfer claim with respect to those transfers to the extent that the subsidiary was insolvent at that time. See Third Interim Report, Annex 1 to Appendix J (Avoidance Actions), at 22 n.56. In addition, because Enron guaranteed many of the obligations of ENA under commodity swaps, total return swaps and similar derivative instruments in connection with the SPEs, if both Enron and ENA were insolvent at the time of the execution of the guaranty, the Enron estate may be able to assert that it did not receive reasonably equivalent value as a result of the incurrence of the obligation under the guaranty. The success of this type of avoidance claim would require, among other things, a finding of insolvency on the part of Enron and the applicable subsidiary as well as a finding that the value of the bundle of rights received by Enron in connection with the transaction was less than reasonably equivalent value for the obligations incurred. That bundle of rights could include, among other things, cash received by Enron by virtue of Enron's cash management system (although upon Enron's receipt of such funds, an intercompany debt to the subsidiary was created) as well as a contingent claim against the subsidiary for indemnification, contribution or subrogation in the event Enron was required to honor the guaranty, even if that claim was subject to a standstill provision. Report is on additional persons and entities that may have liability under applicable legal standards for the Debtors' misuse of its SPE struct~res.~~ Specifically, in this Report the Examiner concludes that: Andersen There is sufficient evidence fiom which a fact-finder could conclude that Andersen: (i) committed professional negligence in the rendering of accounting services to Enron; and (ii) aided and abetted certain Enron officers in breachmg their fiduciary duties to Enron by causing Enron to enter into SPE transactions that were designed to manipulate the Debtors' financial statements and that resulted in the dissemination of financial information known by these officers to be materially misleading. Because Enron's officers participated in the wrongful conduct, however, Andersen may assert that the actions by the Enron officers should be imputed to Enron and consequently, that claims by Enron should be barred or reduced under comparative fault rules." In-house Attorneys There is sufficient evidence fiom which a fact-finder could conclude that certain Enron in-house attorneys committed legal malpractice by: (i) failing to advise Enron adequately regarding the disclosure of its SPE transactions, including the related party transactions; (ii) failing to lo The scope of the Examiner's investigation is limited by the terms of the April 8" Order. Generally, the Reports do not address any potential causes of action that may arise as a result of any transactions or arrangements that do not involve the Debtors' use of SPEs or other matters specifically identified in the April 8" Order. For example, many of the financial institutions discussed in the Reports were involved in transactions and arrangements with Enron that are not related to subjects listed in the April 8" Order and, as a consequence, the Examiner generally expresses no opinion as to whether there are potential causes of action that may arise as a result of such other transactions or arrangements. In the Prior Reports, the Examiner analyzed and reported on certain legal, structural and accounting issues that arose fiom Enron's SPE transactions. In the course of that analysis, the Examiner identified a number of third parties whose relationships with Enron appeared to warrant further investigation given the scope of the April 8" Order. Generally, these parties had the most significant involvement in Enron's SPE transactions and the most substantial claims against the Debtors' estates. Furthermore, the Examiner analyzed and discussed various causes of action that may be available to the Debtors in each of the Reports. Neither the identified third parties nor causes of action are necessarily exhaustive. In many cases, there may be alternative theories or claims that could be available to the Debtors against the parties identified in the Reports or others, which the Debtors may or may not elect to pursue. As used in this report, "comparative fault rules" include Texas' "Proportionate Responsibility" statute, l' Tex. Civ. Prac. & Rem. Code Ann. $9 33.001-002, and the equitable principle of in pari delicto. The legal standards applicable to Andersen, including comparable fault rules, are discussed in detail in Annex 2 to Appendix B (Role of Andersen). It is possible that choice of law determinations could require consideration of similar doctrines that impact Enron's standing to bring such claims.