## Facts

- Dynegy Inc. was a publicly traded Illinois corporation headquartered in Houston, Texas, engaged in energy production, delivery, and energy trading; its shares were registered under Exchange Act §12(b) and traded on the NYSE.
- In Dynegy’s energy-trading segment, the company used mark-to-market accounting for certain trading contracts. Increases in contract values could be reported as net income even when they did not generate cash.
- By around 2000, analysts and others noticed a widening gap between Dynegy’s reported net income and its operating cash flow, raising questions about valuation and liquidity.
- Dynegy sought ways to reduce the reported gap between net income and operating cash flow and, after extensive internal planning and discussions with outside advisors, implemented a structured transaction known as “Project Alpha.”
- Project Alpha used a complex arrangement that included multiple loans, special-purpose entities, a gas-purchase agreement, and related hedging transactions.
- As structured and recorded, Project Alpha caused Dynegy to report approximately $300 million as cash flow from operating activities, even though the SEC found the $300 million was, in substance, loan proceeds that Dynegy effectively routed through the structure so that it was, in economic effect, lending money to itself.
- The SEC found Dynegy’s classification of the $300 million as operating cash flow was inconsistent with GAAP and made Dynegy’s financial reporting materially misleading about liquidity and cash generation from operations.
- The SEC also addressed Dynegy’s reporting about its energy-trading activity. Dynegy’s trading volumes were inflated by “round-trip” or “wash” trades—simultaneous, prearranged buy-and-sell trades with the same counterparty, at the same price, volume, and term—resulting in no profit or loss for either party.
- Dynegy issued press releases in early 2002 that included trading-volume information the SEC found was materially misleading because it included volumes created by the round-trip trades without disclosing their lack of economic substance.
- The Commission instituted a settled administrative proceeding. Dynegy submitted an offer of settlement and consented to the entry of an SEC order without admitting or denying the findings (except as to jurisdiction).

## Issues

1. Whether Dynegy’s accounting and disclosures for Project Alpha misrepresented a financing transaction as operating cash flow, resulting in materially misleading statements or deceptive conduct in violation of the federal securities laws.
2. Whether Dynegy’s public statements about trading volumes were materially misleading because they included undisclosed round-trip trades that created volume without economic effect.
3. Whether Dynegy violated or caused violations of Exchange Act reporting, books-and-records, and internal-controls requirements by recording and reporting Project Alpha and the related disclosures in a manner inconsistent with GAAP and accurate recordkeeping.

## Decision

- The SEC instituted an administrative cease-and-desist proceeding under Securities Act §8A and Exchange Act §21C and accepted Dynegy’s offer of settlement.
- The SEC found that Dynegy engaged in securities fraud in connection with its disclosures and accounting for Project Alpha, including the classification of approximately $300 million of loan proceeds as operating cash flow.
- The SEC found that Dynegy negligently included materially misleading information about round-trip energy trades in two press releases issued in early 2002.
- The SEC found Dynegy violated or caused violations of antifraud provisions, including Securities Act §17(a) and Exchange Act §10(b) and Rule 10b-5.
- The SEC found Dynegy violated or caused violations of Exchange Act reporting provisions, including §13(a) and related rules governing periodic reports and required disclosure.
- The SEC found Dynegy violated or caused violations of Exchange Act §13(b)(2)(A) (books and records) and §13(b)(2)(B) (internal accounting controls).
- The SEC ordered Dynegy to cease and desist from committing or causing violations of the cited Securities Act and Exchange Act provisions.
- In a related federal civil action, Dynegy agreed to pay a $3 million civil penalty.
- The settlement was entered on a neither-admit-nor-deny basis (except as to jurisdiction).

## Legal Principles

- A registrant may not present financing cash inflows as operating cash flow when, in substance, the cash is loan proceeds; misclassification can be materially misleading because operating cash flow is widely used to assess liquidity and the ability to generate cash from core business activity.
- Compliance with GAAP matters for federal securities-law reporting; filing financial statements not in conformity with GAAP may support antifraud and reporting violations when the errors are material.
- The federal securities laws look to economic substance, not labels or transaction form; using special-purpose entities and multiple steps does not cure misleading presentation if the transaction functions as financing.
- Statements about trading volume can be materially misleading when they include round-trip trades that create the appearance of market activity but have no profit-and-loss effect and no real economic purpose.
- Exchange Act §13(b) requires issuers to maintain books and records that accurately and fairly reflect transactions and to maintain internal accounting controls that provide reasonable assurance transactions are properly authorized, recorded, and reported.

## Conclusion

In *In the Matter of Dynegy Inc.*, Exchange Act Release No. 46537 (Sept. 24, 2002), the SEC found that Dynegy used Project Alpha to report about $300 million of loan proceeds as operating cash flow in a manner inconsistent with GAAP and materially misleading to investors, and that Dynegy also issued early-2002 press releases with trading-volume figures that were misleading because they included undisclosed round-trip trades; the SEC imposed a cease-and-desist order, and Dynegy paid a $3 million penalty in a related civil settlement.


In the Matter of Dynegy Inc., Securities Exchange Act Release No. 46537 (2002)