JP Morgan Off The Hook For Enron Related Class Action

Despite the Supreme Court's ruling in Tellabs, the Second Circuit continues to apply its two prong motive and opportunity or strong circumstantial evidence test. In ECA and Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., Case No. 0-1786-cv (2nd Cir. Jan. 21, 2009) the Second Circuit affirmed the District Court’s dismissal for failure to sufficiently plead scienter.

The case addressed the issue of whether the complaint adequately alleged (1) a false statement or omission of material fact, and (2) a strong inference of scienter.

A plaintiff must establish that the defendant made a materially false statement or omitted a material fact, with scienter. The complaint must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(1), (2); Tellabs, 127 S. Ct. at 2508.

The Second Circuit's test required that the complaint allege facts that show either (1) that defendants had the motive and opportunity to commit fraud, or (2) strong circumstantial evidence of conscious misbehavior or recklessness.

The shareholders alleged that J.P. Morgan Chase ("JPMC") defrauded them by downplaying its Enron-related exposure, failing to disclose alleged violations of law in connection with a JPMC entity (Mahonia) and other transactions. More specifically, the shareholders alleged they were defrauded based on JPMC's provision of “disguised” loans to Enron. JPMC essentially created a special purpose entity called Mahonia that borrowed money from JPMC and used that money to buy gas from Enron; Mahonia would then satisfy its debt to JPMC by providing the gas to JPMC, which would resell the gas at a fixed future price back to Enron. In reality, neither the physical commodity nor title to it was ever intended to be transferred.

The court reasoned that the improper classification of the loans as trading assets was immaterial in this case because both quantitative and qualitative factors must be considered in determining materiality. Here, the quantitative factor strongly supported JPMC’s argument that the classification error, if it was one, was immaterial. ECA, Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 2009 WL 129911, 11 (2nd Cir. 2009).

The district court said, “[c]hanging the accounting treatment of approximately 0.3% of JPM Chase’s total assets from trades to loans would not have been material to investors.” JP Morgan Chase I, 363 F.Supp.2d at 631.

Because Plaintiffs failed to adequately plead that JPMC made materially false statements or omitted material facts with scienter, the court held that Plaintiffs’ SAC could not survive JPMC’s Fed.R.Civ.P. 12(b)(6) motion to dismiss.




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