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One week after agreeing to pay out $2 billion to settle claims arising from its role as an underwriter for WorldCom, JPMorgan Chase won an important victory in a securities fraud case arising from its dealings with Enron. In a 61-page opinion dated Monday, Southern District of New York Judge Sidney Stein granted JPMorgan’s motion to dismiss a securities class action brought by the bank’s shareholders. Plaintiffs claimed JPMorgan misstated its financial exposure arising from transactions it had entered into with Enron, which plaintiffs say were intended to help perpetuate Enron’s fraud. Shareholders alleged that the specific transactions involved loans made by JPMorgan to Enron disguised as trades, and the establishment of off-balance sheet entities Enron used to hide debt. When news of JPMorgan’s alleged involvement in Enron became public, its stock price fell, triggering the class action by injured shareholders of the bank. The decision, In Re JP Morgan Securities Litigation, 02 Civ. 1282, meticulously considered plaintiffs’ allegations. But Judge Stein concluded that plaintiffs failed to meet the standard of proof required in a securities class action and dismissed the claims. A securities fraud claim must meet the heightened pleading standards set out in the 1995 Private Securities Litigation Reform Act, said Stein. The key element of the act, he said, “requires particularity in the pleading of the requisite mental state.” To prove that JPMorgan’s financial statements were fraudulent, he wrote, plaintiffs were required to show that JPMorgan made “materially false statements … with scienter.” Establishing scienter is not an easy task. Plaintiffs must either show that JPMorgan had the motive and opportunity to commit fraud or show facts “that constitute strong circumstantial evidence of conscious behavior or recklessness,” said Stein, referring to the standard set by the 2nd U.S. Circuit Court of Appeals. In presenting each example of the motives JPMorgan and its executives may have had, the judge found that plaintiffs offered generalizations rather than specific instances needed for scienter. Stein applied the same reasoning in rejecting a case for “circumstantial evidence,” the second prong of the scienter standard. Because JPMorgan continued to provide Enron with new capital up to the time of the company’s collapse, the judge concluded that the defendant was unlikely to know that Enron was on the verge of collapse. Therefore, it could not have been expected to reveal its exposure in financial statements before the collapse actually took place. Stein did find that plaintiffs pleaded scienter with the requisite particularity in connection with the fact that JPMorgan’s prepay transactions with Enron were characterized improperly as trading assets rather than as loan assets. He ruled, however, that this distinction by itself was not material to investors. Bruce Angiolillo of Simpson Thacher & Bartlett represented JPMorgan Chase. Joseph Weiss of Weiss & Lurie and Steve Berman of Seattle-based Hagens, Berman represented the plaintiffs.

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