Free Affidavit - District Court of Delaware - Delaware

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Exhibit 39

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IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF DELAWARE _______________________________________ : MAGTEN ASSET MANAGEMENT : C.A. No. 05-499 (JJF) CORPORATION : : Plaintiff : : v. : : MIKE J. HANSON and ERNIE J. KINDT : : Defendants : _______________________________________

CONFIDENTIAL, SUBJECT TO PROVISIONS OF CONFIDENTIALITY AGREEMENT

Expert Report by Stephen J. Scherf, CPA October 17, 2007

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TABLE OF CONTENTS
1. BACKGROUND ................................................................................................................. 2 2. BASIS FOR ANALYSIS ...................................................................................................... 3 3. ANALYSIS ........................................................................................................................ 4 3.1. QUIPS ...................................................................................................................... 5 3.2. NORTHWESTERN ENERGY TRANSACTION ................................................................. 8 3.3. "ZONE OF INSOLVENCY" ......................................................................................... 10 3.4. DOCUMENTS AND INFORMATION AVAILABLE TO KINDT AND HANSON................... 13 3.4.1. Information and Documents Available to Kindt............................................. 14 3.4.2. Information and Documents Available to Hanson.......................................... 16 3.4.2.1. Monthly Financial and Information Reports ("MFIRs")........................ 16 3.4.2.2. Board of Directors' Information.............................................................. 18 3.4.2.3. NCS Audit Report..................................................................................... 20 3.4.2.4. Board Questions Concerning Lewis and Hylland ................................... 22 3.4.2.5. Request for Bonus Compensation ............................................................ 22 3.4.2.6. Summary .................................................................................................. 23 3.4.3. Plaintiff's Analysis.......................................................................................... 23 3.5. INTERNAL AND EXTERNAL INVESTIGATIONS OF NORTHWESTERN .......................... 24 3.5.1. Board of Directors Investigations ................................................................... 25 3.5.2. Gibson Dunn Investigation ............................................................................. 25 3.5.3. SEC Activities................................................................................................. 26 3.6. OBSERVATIONS CONCERNING THE BERLINER AND MARCUS REPORTS ................... 27 3.6.1. Observations Concerning the Berliner Report................................................ 27 3.6.2. Observations Concerning the Marcus Report ................................................. 30 3.6.2.1. Opinion 1 ­ Given Knowledge of Errors & Omissions Asset Transfer Impeded................................................................................................................. 31 3.6.2.2. Opinion 2 ­ Absent Transfer QUIPS Investors Covered by NorthWestern Energy Assets ........................................................................................................ 34 3.6.2.3. Opinion 3 ­ Solvency of Clark Fork ........................................................ 35 4. CONCLUSION ................................................................................................................. 35

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Stephen J. Scherf Managing Director [email protected] p 215.568.5788

2 Penn Center Plaza, Suite 1730 1500 John F. Kennedy Boulevard Philadelphia, PA 19102 www.esba.com

CONFIDENTIAL, SUBJECT TO PROVISIONS OF CONFIDENTIALITY AGREEMENT

MAGTEN ASSET MANAGEMENT CORPORATION V. MIKE J. HANSON AND ERNIE J. KINDT

Our firm was engaged by Defendants' counsel (Browning, Kaleczyc, Berry & Hoven, P.C.) to assess the allegations made by Magten Asset Management Corporation ("Magten" or "Plaintiff") in its suit against Michael J. Hanson ("Hanson") and Ernie J. Kindt ("Kindt") (collectively the "Defendants"). In addition, it was requested that we provide our observations concerning the Expert Reports of Robert W. Berliner ("Berliner") and Paul A. Marcus ("Marcus") each dated September 19, 2007. This report sets out the results of our analysis and is structured as follows: 1. 2. 3. 4. Background Basis for Analysis Analysis Conclusions Exhibits

Executive Sounding Board Associates Inc. New York, NY Philadelphia, PA Baltimore, MD* Falls Church, VA Wilmington, DE Charlotte, NC
*In Maryland known as ESBA

Capital Group Inc.

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1. BACKGROUND
The Montana Power Company ("Montana Power") was engaged in telecommunications and energy related activities including oil, coal, natural gas and electricity. In November 1996, Montana Power issued Quarterly Income Preferred Securities ("QUIPS") with a total face amount of $65 million. In March 2000 Montana Power decided to focus its efforts on its telecommunications business and announced plans to restructure its business. In September 2000, Montana Power entered into a Unit Purchase Agreement with NorthWestern Corporation ("NorthWestern") wherein NorthWestern agreed to purchase the Montana utility business of Montana Power, subject to regulatory approval. Upon obtaining such regulatory approval, NorthWestern was allowed to purchase the assets and to hold them either in the form of a wholly owned entity or as a division of NorthWestern. In February 2002, NorthWestern acquired the ownership interests of the Montana Power1 utility business for $478 million in cash and the assumption of $511 million in debt and preferred securities.2 Included in the liabilities assumed by NorthWestern as part of the transaction were the QUIPS. According to press releases and other statements, NorthWestern made it clear to the public that the Montana utility business (now known as NorthWestern Energy, LLC ("NorthWestern Energy")), would eventually become a division of NorthWestern, rather than being held as a separate entity. NorthWestern initially applied for a temporary exemption to hold the energy related assets and liabilities in a separate subsidiary, and ultimately converted NorthWestern Energy into a division of NorthWestern. On November 15, 2002 NorthWestern exchanged its equity interest in NorthWestern Energy for direct ownership of the individual assets and liabilities, excluding the Milltown Dam assets and liabilities.3

The equity interests were the membership units of Montana Power, LLC that NorthWestern subsequently re-named NorthWestern Energy, LLC. 2 NorthWestern Form 10-K for the period ended December 31, 2002 filed April 15, 2003, page 5. 3 NorthWestern Energy, LLC subsequently changed its name to Clark Fork and Blackfoot, LLC ("Clark Fork").

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We understand that Magten began to purchase QUIPS in or around April 20034 and continued to purchase QUIPS even after NorthWestern filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the District of Delaware on September 14, 2003.5 Magten currently owns in excess of 33 percent of the QUIPS. In April 2004, Magten filed suit alleging damages as a result of a breach of fiduciary duty by Hanson and Kindt, who were officers of NorthWestern Energy at the time of the November 15, 2002 transaction.

2. BASIS FOR ANALYSIS
The analysis and opinions in this report are based upon the documentation available to date and my experience in performing similar financial and forensic analyses. I have been qualified and presented testimony on numerous occasions in courts throughout the United States. I am a Certified Public Accountant, a Certified Fraud Examiner, a Certified Forensic Accountant, and have a Master of Science degree with a concentration in Finance. Furthermore, I have been an officer of several organizations including being a Senior Vice President of a $2.5 billion financial institution and Chief Financial Officer of two privately held organizations. I am a Managing Director with ESBA. My current curriculum vitae and information concerning my testimony history, publications and speaking engagements is attached as Exhibit A. I, and others under my direct supervision, have performed this analysis with the documentation available to date. Accordingly, we reserve the right to supplement and/or amend our analysis and this report should additional or updated information become available. When I testify at trial, I may illustrate my testimony with demonstrative aids such as graphs, charts and/or slides.

4 5

July 12, 2007 Deposition of Talton R. Embry, page 14. July 12, 2007 Deposition of Talton R. Embry, page 49.

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Our analysis was based on the documentation listed in Exhibit B. The documents and information utilized are the types of documents and information experts in my field typically rely upon in performing such an analysis. Our firm is being compensated at rates of $125 to $425 per hour. Our compensation is not contingent upon the outcome of this litigation.

3. ANALYSIS
As will be shown in the analysis that follows, Plaintiff has failed to establish the proper relationship between the loss that they have allegedly suffered and the alleged breach of fiduciary duty by Hanson or Kindt. Plaintiff has failed to properly account for the risks that they assumed in purchasing the QUIPS, has failed to properly analyze and calculate their damages, and has failed to show that Hanson and/or Kindt knew or should have known about the financial misstatements of NorthWestern and its subsidiaries. Moreover, Plaintiff has employed two experts that have prepared speculative analyses and have failed to show any causal relationship between the alleged breach of fiduciary duty of Hanson and Kindt and the damages asserted. As a result, their expert reports are not reliable and/or relevant. Our analysis is structured as follows: · · · · · · QUIPS NorthWestern Energy Transaction "Zone of Insolvency" Documents and Information available to Kindt and Hanson Internal and External Investigations of NorthWestern Observations concerning the Berliner and Marcus Reports

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3.1. QUIPS QUIPS are defined as "shares that are an interest in a limited partnership that exists solely for the purpose of issuing preferred securities and lending the proceeds of the sales to its parent company. They usually have a $25 par value, NYSE listing and cumulative quarterly distributions."6 companies to obtain funds. On or about November 6, 1996, Montana Power issued 2,600,000 40 year preferred securities under a QUIPS offering, with a total face value of $65 million. Montana Power Capital was formed under the laws of the State of Delaware to act as the statutory business trust for Montana Power. Montana Power was to be the owner of all the beneficial interests represented by common securities ("trust securities") of Montana Power Capital. Montana Power Capital's existence was for the sole purpose of issuing trust securities and investing the proceeds in junior subordinated deferrable interest debentures ("junior subordinated debentures") to be issued by Montana Power.7 According to the offering memorandum, the Montana Power QUIPS were subject to the following risks: · Dependence of Montana Power Capital on Montana Power for funds; subordination of junior subordinated debentures and guarantee:
"The ability of Montana Power Capital to pay amounts due on the Preferred Securities is solely dependent upon [Montana Power] making payments on the Junior Subordinated Debentures as and when required. [Montana Power's] obligations under the Junior Subordinated Debentures and the Guarantee are unsecured, subordinated and junior in right of payment to Senior Indebtedness of [Montana Power]."

In essence, they are long-term debt instruments used by

Obtained from Investopedia. Montana Power Capital I ("Montana Power Capital")8.45% Cumulative Quarterly Income Preferred Securities, Series A (QUIPS) Prospectus, page i.
7

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·

Option to extend interest payment period; tax consequences; potential market volatility during extension period:
"So long as no Debenture Event of Default shall have occurred and be continuing, [Montana Power] has the right to defer payments of interest on the Junior Subordinated Debentures for Extension Periods of up to 20 consecutive quarters... If interest payments are so deferred, distributions on the Preferred Securities also will be deferred..."

·

Rights under the guarantee; limited funds available to Montana Power Capital:
"The Guarantee guarantees to the Holders of the Preferred Securities the payment and not the collection of (i) any accrued and unpaid distributions required to be paid on the Preferred Securities, but only if and to the extent that the Property Trustee has available funds sufficient to make such payment... If [Montana Power] were to default on its obligations under the Junior Subordinated Debentures, Montana Power Capital would lack available funds for the payment of distributions or amounts payable on redemption of the Preferred Securities or otherwise, and in such event Holders of the Preferred Securities would not be able to rely upon the Guarantee for payment of such amounts. The Guarantee will constitute an unsecured obligation of [Montana Power] and will rank subordinate and junior in right of payment to all Senior Indebtedness of [Montana Power]."

·

Special event redemption:
"Upon the occurrence and continuation of a Special Event, [Montana Power] has the right to redeem the Junior Subordinated Debentures, in whole but not in part, within 90 days following the occurrence of such Special Event and thereby cause a mandatory redemption of the Preferred Securities at the Redemption Price."

·

Distribution of junior subordinated debentures upon termination, potential adverse effect upon market price:
"[Montana Power] shall have the right to terminate Montana Power Capital at any time and cause the Junior Subordinated Debentures to be distributed to the Holders of Trust Securities in liquidation of Montana Capital Power."

·

Limited voting rights:
"Holders of Preferred Securities generally will have limited voting rights relating only to the modification of the Preferred Securities and the direction of remedies upon the occurrence of an Event of Default under the Trust Agreement. Holders of Preferred Securities will not be entitled to vote to appoint, remove or replace any Trustees, which voting rights are vested exclusively in the Holder of the Common Securities, except upon the occurrence of certain events..."

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·

No established trading market for the preferred securities, trading price, potential adverse income tax effect.
"The Preferred Securities have been approved for listing on the NYSE. The Preferred Securities may trade at a price that does not fully reflect the value of accrued but unpaid interest with respect to the underlying Junior Subordinated Debentures."

Based upon our analysis of the offering memorandum and other research on QUIPS, a transaction such as the NorthWestern Energy acquisition could occur, and principal and interest under the QUIPS was not guaranteed. QUIPS are also subject to the same risks associated with Montana Power. These risks include but are not limited to the utility business being subjected to extensive environmental regulations, such as the Clean Air Act Amendment of 1990, and potential environmental liabilities governed by the U.S. Environmental Protection Agency, which could result in significant costs and liabilities. In addition, a changing economic environment can cause disruptions in the financial markets, resulting in the lower availability of credit or a higher cost of capital. Furthermore, changes in the commodity prices can cause either an increase in costs to produce and distribute electricity and natural gas or a decrease in the amount received from selling electricity and natural gas. Lastly, considering that the electric and gas utility business is a seasonal business, operating results can fluctuate according to this factor.8 Subsequent to the November 15, 2002 transaction, NorthWestern made timely payments on account of the QUIPS in December 2002 and March 2003. We understand that NorthWestern elected under the terms of the QUIPS to defer the June 2003 payment. As a result of the bankruptcy filing, the QUIPS defaulted. Prior to the filing of the bankruptcy, however, no default had occurred with respect to the QUIPS. As noted previously, we understand that Magten initially started purchasing the QUIPS in April 2003, subsequent to the November 15, 2002 transfer in question. Furthermore, we understand that Magten continued to purchase additional QUIPS after NorthWestern's
8

These risks were identified in NorthWestern Corporation's April 24, 2002 Form S-4 filing, pages 10 through 15. Montana Power is also subject to the same risks as both companies are in the Energy industry.

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bankruptcy filing. Given the timing of Magten's purchases of the QUIPS, it is clear that they were aware of the risks inherent in this investment. We understand that any plaintiff has a duty to mitigate its damages; Magten's continuing purchases of the QUIPS does not appear consistent with that duty. 3.2. NORTHWESTERN ENERGY TRANSACTION As noted previously, NorthWestern purchased the equity interests of Montana Power, LLC in February, 2002 for "$478 million in cash and the assumption of $511 million in existing debt and mandatory redeemable preferred securities."9 Given its regulatory approval, NorthWestern had the ability to hold the assets directly or in the form of a subsidiary.10 "As a result of the acquisition, from February 15, 2002, the closing date of the acquisition, through November 15, 2002, we [NorthWestern] distributed electricity and natural gas in Montana through our wholly owned subsidiary, NorthWestern Energy LLC. Effective November 15, 2002, we [NorthWestern] transferred all of the energy and natural gas transmission and distribution operations of NorthWestern Energy LLC to NorthWestern Corporation and since that date, we have operated that business as part of our NorthWestern Energy division."11 While the February and November 2002 transactions occurred nine months apart, they are clearly part of the same transaction. Months prior to the February 2002 closing, on October 16, 2001, NorthWestern told its rating agencies that it intended to hold the assets as part of NorthWestern.12 This position was reiterated in NorthWestern's April 30, 2002 First Quarter 2002 Earnings conference call.13 Furthermore, in the prepared testimony dated August 27, 2001 of Hanson before the Public Service Commission of the State of Montana, the following was disclosed:
9

NorthWestern Form 10-K for the period December 31, 2002 filed April 15, 2003, page 5. It should be noted that had NorthWestern elected to acquire the assets in February 2002 as a division, the lawsuit against Hanson and Kindt could not exist. 11 NorthWestern Form 10-K for the period December 31, 2002 filed April 15, 2003, page 5. 12 NorthWestern Rating Agency Presentation, October 16, 2001 (CSFB015656) [Marcus Report, page 8]. 13 NorthWestern, Transcript from First Quarter 2002 Earnings conference call, April 30, 2002, page 54. (NOR379816) [Marcus Report, page 8].
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"NorthWestern [NorthWestern Public Service] plans to make the requisite filings, and take the other steps necessary, to authorize it to obtain exempt status under the Public Utilities Holding Company Act, as amended, with both MPC [Montana Power Company] and NorthWestern Public Service becoming subsidiaries of the parent corporation [NorthWestern Corporation]. If NorthWestern ultimately does not implement a holding company structure, then upon closing of the transaction, it will retain its current divisional structure and MPC will become a division rather than a subsidiary of the company."14

In its November 20, 2002, Form 8-K, NorthWestern stated, "On November 20, 2002, NorthWestern Corporation ("NorthWestern") issued the press release attached hereto as Exhibit 99.1 and completed the final stage of its acquisition of the Montana utility operations of its subsidiary NorthWestern Energy, L.L.C." The press release describes the transaction in more detail as follows:
"SIOUX FALLS, S.D. ­ Nov. 20, 2002 ­ NorthWestern Corporation (NYSE:NOR) today announced that it has completed its previously announced plan to restructure its Montana utility operations as a division of NorthWestern Corporation. The restructuring involved the intra-company transfer of substantially all of the assets and liabilities of NorthWestern Energy, L.L.C. to NorthWestern Corporation. NorthWestern Energy, L.L.C. had substantially been comprised of the former Montana Power Company transmission and distribution business acquired by NorthWestern in February 2002. `This action completes our previously announced plan to hold our regulated utility operations at the parent level as operating divisions of NorthWestern Corporation in what is known as a `flat structure',' said Eric Jacobson, NorthWestern senior vice president and general counsel. `Our Montana utility operations will be conducted by the NorthWestern Energy division of NorthWestern Corporation and its operations and customers will not be affected by the structural change.' "

The November 15, 2002 transaction that occurred between NorthWestern Energy and NorthWestern was at fair market value, meaning reasonably equivalent value was given and received. While the documentation of the transaction was more complicated,15 in essence NorthWestern relinquished its right to hold the assets in a subsidiary for the right to hold those assets directly. In other words, NorthWestern exchanged its membership

Testimony of Michael J. Hanson of NorthWestern Corporation before the Public Service Commission of the State of Montana, In the Matter of the Joint Application for Approval of the Sale of Montana Power Company to NorthWestern Corporation, page 4 (NOR044696) 15 Certain assets and liabilities remained in NorthWestern Energy, subject to assumption and support agreements.

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units (which would be valued at the equity value16 of the subsidiary) for the value of the assets less the liabilities. As noted by Kindt, "there, wasn't a whole lot of activity that was required on the books"17 to record the transaction. 3.3. "ZONE OF INSOLVENCY" Magten has asserted in its complaint against Hanson and Kindt that NorthWestern Energy was in the "zone of insolvency" on November 15, 2002 and that as a result, Hanson and Kindt, as officers of NorthWestern Energy, owed a duty to NorthWestern Energy's creditors. We note that in its complaint against NorthWestern, Magten has asserted that prior to the transfer to NorthWestern, NorthWestern Energy was a solvent and reasonably capitalized entity. Prior to the November 15, 2002 transaction, we understand Hanson and Kindt, as officers of NorthWestern Energy, owed their fiduciary duty to the sole member and manager of NorthWestern Energy (i.e. NorthWestern). Magten's experts, Berliner and Marcus, conclude that Clark Fork became insolvent assuming that Clark Fork remained directly obligated under QUIPS following the November 15, 2002 transaction. As part of the transaction, NorthWestern agreed:
"to assume on the Closing Date [November 15, 2002], and to pay or perform, in accordance with their terms, any and all obligations and liabilities of Transferor [NorthWestern Energy], direct or indirect, known or unknown, absolute or contingent, arising or relating to the period before the Closing, except the Excluded Liabilities."
18

The excluded liabilities did not include the obligations under the QUIPS, and as a result, NorthWestern became fully responsible for the payment of the QUIPS. perspective. Given the forgoing, the assumption made by Berliner and Marcus is not appropriate from a business

16 17

From a valuation and accounting perspective equity is defined as assets less liabilities. June 28, 2007 Deposition of Ernie J. Kindt, page 18. 18 Asset and Stock Transfer Agreement dated November 15, 2002, page 5.

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We note that NorthWestern did not directly acquire certain assets and liabilities of Clark Fork, primarily those associated with the Milltown Dam. However, NorthWestern did agree to provide support to Clark Fork through several agreements, including a Maintenance and Operating Costs Support Agreement, Employee Secondment and Administrative Services Agreement, and Environmental Liabilities and Support Agreement. The intent of these agreements was to ensure that Clark Fork would remain solvent after the transfer. For example, NorthWestern agreed "that it shall cause Subsidiary [Clark Fork] to have at all times a net worth, as determined in accordance with generally accepted accounting principles in the United States of America, of at least US$1,000."19 Based upon what Hanson and Kindt knew or should have known at the time of the November 15, 2002 transaction, and as prudent business persons, Hanson and Kindt had the right to rely upon the agreements and their anticipated effect. Assuming for the moment that the November 15, 2002 transaction should be viewed as a separate transaction (a proposition which with we disagree) rather than a continuation of the February 2002 purchase transaction,20 in order for Hanson's and Kindt's fiduciary duty to favor the creditors, they would had to have known that the transaction rendered Clark Fork insolvent. Given the structure of the November 15, 2002 transaction, including the assumption and support agreements provided by NorthWestern, Clark Fork could have been insolvent or in the "zone of insolvency" on November 15, 2002 only if NorthWestern was insolvent on that date. On November 15, 2002 NorthWestern's stock was trading at $7.43 per share, resulting in a market capitalization of approximately $278 million. This information would indicate that the market viewed NorthWestern as solvent on that

Environmental Liabilities Support Agreement. Support for viewing the transaction as one include statements by NorthWestern to regulatory and rating agencies prior to the transaction and statements to the public after the transaction that NorthWestern intended to eventually have the Montana Power assets operated as a division rather than as a separate subsidiary. In addition, the original PUCHA application anticipated the two step transaction structure that occurred.
20

19

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date.21 Furthermore, even assuming all the Berliner adjustments, some of which are based upon hindsight, even Berliner estimated22 that NorthWestern was solvent on November 15, 2002 under Generally Accepted Accounting Principles ("GAAP").23 We are not aware of any analysis that has concluded that NorthWestern was insolvent or even in the "zone of insolvency" as of November 15, 2002. Assuming, for the sake of argument, that based upon the facts in this matter Hanson and Kindt needed to evaluate the transaction from the vantage point of creditors, a point with which we disagree, in order for Hanson and Kindt to be liable for damages, one would have to establish that Hanson and Kindt did not exercise reasonable business judgment in allowing the transaction to move forward. In addition, we understand that typically a liability determination in a deepening insolvency or "zone of insolvency" matter is based upon whether there was actual fraud on the part of the defendants. We understand that Berliner and Marcus allege fraudulent activities on the part of management of NorthWestern.24 Our analysis of their reports and other documents produced in this matter (which will be addressed in later sections) do not indicate that the management that knew or should have known of the alleged fraudulent activities included Hanson or Kindt.25 Furthermore, if liability is established, damages need to be calculated. It is our

understanding that the damages related to a deepening insolvency or "zone of
21

We have seen no analysis that would indicate the effect on the market that the restatements would have had had they been known as of November 15, 2002. However, we do note that on April 15, 2003, the day the restated financials were filed with the SEC, NorthWestern still had a positive stock price of $2.27 and a resultant market capitalization of approximately $85 million. 22 Expert Report of Robert W. Berliner, CPA, CFE, dated September 19, 2007 ­ [Appendix A-4] Total Assets in (000s) of $3,142,134 less total liabilities of $3,075,238 (000s) equals $66,896 (000s). 23 We understand that for determining solvency, GAAP based principles do not control. In addition, as will be shown later in the report Hanson and Kindt had no reason to be aware of the restatement adjustments, or the additional adjustments (with which we disagree), that Berliner proposes. These additional adjustments serve to lower his GAAP based determination of solvency. 24 We were engaged to evaluate what Hanson and Kindt knew or should have known concerning the financial condition of NorthWestern in connection with their execution of the required November 15, 2002 transaction documents as mandated by the sole member and manager, NorthWestern. We were not engaged to evaluate the activities of other members of NorthWestern's management; therefore we have not done so and offer no opinion with respect to their actions. 25 It should be noted that Kindt was not an officer of NorthWestern on November 15, 2002.

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insolvency" matter, to the extent that such claims are even viable, should be quantified by reference to the decline in value of the equity caused by the harm. That is to say, there is something less available to the creditors as a result of the alleged actions. In calculating such damages one needs to consider segregating the following items: · Losses that are the result of the good faith efforts of officers to improve operations from those that resulted from the alleged harmful actions of the defendants or in this case the alleged harmful actions of others. · · Losses that may have occurred based upon the mere passage of time. Losses caused by alleged negligence versus those caused by alleged fraudulent activities. We understand that Plaintiff's claim that their damages equal the total principal and interest that would have been contractually due at the time of judgment had NorthWestern not filed for bankruptcy and paid off the QUIPS in full.26 As noted above, the return of principal on the QUIPS is not due until 2036. Thus, Plaintiff's calculation of damages is methodologically flawed, overly simplistic, speculative, and would have a tendency to overstate damages in that it assumes a premature return of principal, does not consider amounts available under the NorthWestern plan of reorganization and does not properly measure all the risks and relevant factors facing the holder of the QUIPS. 3.4. DOCUMENTS AND INFORMATION AVAILABLE TO KINDT AND HANSON We obtained documents and information that were available to Hanson and Kindt for the period from December 2001 through November 15, 2002 to determine what they knew or should have known about the financial condition of NorthWestern and NorthWestern Energy at the time of the November 15, 2002 closing. We have segregated our analysis into those documents and information available to Hanson and those available to Kindt.
We understand that Plaintiff is also seeking consequential, incidental and punitive damages. (Magten Asset Management Corporation's response to Michael J. Hanson and Ernie J. Kindt's First Set of Interrogatories).
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3.4.1. Information and Documents Available to Kindt Prior to the November 15, 2002 transaction, Kindt was an officer of NorthWestern Energy. Kindt was not involved in the decision to transfer the assets from NorthWestern Energy to NorthWestern,27 but rather, was informed that since NorthWestern was denied its exemption to hold NorthWestern Energy separately, a divisional structure would have to be implemented.28 Kindt's involvement in the transaction was out of necessity as he was NorthWestern Energy's chief accounting officer. Kindt was consulted to determine the simplest way to account for the transaction.29 Kindt was not an officer of NorthWestern. As such, Kindt had limited information on NorthWestern other than information that would be available to the general public. As the chief accounting officer of NorthWestern Energy, Kindt had details about NorthWestern Energy's financial condition, but was not privy to the operations or financial condition of NorthWestern, or its various subsidiaries. Kindt did not receive or see the Monthly Financial and Information Reports ("MFIRs") that were provided to certain other NorthWestern employees.30 From his knowledge and experience with NorthWestern, he believed NorthWestern had the "financial wherewithal to continue to service the [QUIPS] debt" and that "whenever the utility needed cash, it was available."31 Kindt indicated that at the time of the transaction, "The balance sheet of NorthWestern was strong. They were a very large company. The company had just recently issued some debt and did not have a difficult time issuing that debt."32 Kindt was not aware of any concerns with respect to the liquidity or cash flow issues of NorthWestern until "the spring, late winter, early spring of 2003"33 ­ after the November 15, 2002 transaction occurred.
27 28

June 28, 2007 Deposition of Ernie J. Kindt, page 23. June 28, 2007 Deposition of Ernie J. Kindt, page 23. 29 June 28, 2007 Deposition of Ernie J. Kindt, page 23. 30 June 28, 2007 Deposition of Ernie J. Kindt, page 50. 31 June 28, 2007 Deposition of Ernie J. Kindt, page 31. 32 June 28, 2007 Deposition of Ernie J. Kindt, pages 86 to 87. 33 June 28, 2007 Deposition of Ernie J. Kindt, page 63.

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In late summer 2002, the treasurer of NorthWestern Energy left the company and Kindt became responsible for the filing requirements under the QUIPS. The filing requirements were contained in a book that listed what needed to be done including items that needed to be filed annually including an officer's certificate.34 Prior to that time period, Kindt had no direct duties with respect to the QUIPS. We understand that Kindt attended only one NorthWestern meeting shortly after NorthWestern purchased the Montana utility business wherein all the former Montana utility business vice presidents attended. "There was a presentation at that conference where the presidents of the various divisions of the company spent ten or 15 minutes updating people on their progress. Expanets at that point in time was confident that they would meet their annual budgeted target which they indicated was an aggressive target."35 Finally, the only other information Kindt would receive on Expanets would be a one-line comparison of net income compared to budget on both a monthly and year-todate basis.36 Therefore, based upon our analysis of the documents and information that was available to Kindt, it is our opinion within a reasonable degree of professional certainty that he did not know and had no reason to know about future potential cash flow issues, alleged misstatements or alleged lack of disclosures by NorthWestern or its various subsidiaries. As such, it was perfectly reasonable and within prudent business judgment for Kindt to execute the required November 15, 2002 transaction documents as mandated by the sole member and manager, NorthWestern.

34 35

June 28, 2007 Deposition of Ernie J. Kindt, pages 14 to 16. June 28, 2007 Deposition of Ernie J. Kindt, page 72. 36 June 28, 2007 Deposition of Ernie J. Kindt, page 72.

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3.4.2. Information and Documents Available to Hanson Hanson is now the President and CEO of NorthWestern. The officers who were senior to Hanson as of November 15, 2002 have since left the company, and as will be described later in this report, many were alleged to have participated in a scheme to mislead investors and the general public concerning the financial condition of NorthWestern. In essence, Hanson was the highest ranking NorthWestern officer at the time of the transaction who was determined by internal, external and Security and Exchange Commission ("SEC") investigators not to be involved in the alleged scheme. As an officer of NorthWestern Energy and as an officer of NorthWestern, Hanson had more information available to him than did Kindt. We have therefore separated this portion of the report into the following sections: · · · · · · Monthly Financial and Information Reports ("MFIRs") Board of Directors Information NCS Audit Report Board Questions Concerning Lewis37 and Hylland38 Request for Bonus Compensation Summary

3.4.2.1. Monthly Financial and Information Reports ("MFIRs") As the officer responsible for the utility businesses of NorthWestern, Hanson received MFIRs. In addition, Hanson attended management meetings wherein the contents of the MFIRs were discussed. The MFIRs contained selected financial information concerning each of the various operating groups of NorthWestern, initially including NCG, CNO, Blue Dot, Expanets and Corporate & Other. The components of the selected information changed over time. By the end of 2002 the various remaining operating groups were
37 38

Chairman of the Board and Chief Executive Officer, retired December 31, 2002. President and Chief Operating Officer of NorthWestern.

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NorthWestern Energy, Corporate & Other, Expanets and Blue Dot. The MFIRs included a balance sheet and income statement for NorthWestern, however no statement of cash flow was provided. Furthermore, the MFIRs did not contain balance sheets, income statements or statements of cash flow for any of the operating groups, making a complete financial analysis of these companies extremely difficult, if not impossible.39 In response to questioning, Hanson noted that "[e]very time they discussed a problem there was also a discussion of actions they were going to do about it and the constant theme was it's going to improve, going to improve."40 Our examination of the underlying documents noted that they changed over time and did not contain enough information to determine the purpose of their use. Therefore any conclusions drawn by Hanson from the information could be subject to interpretation or may be speculative. During the periods May, June, and July, 2002, the MFIRs contain information in a graph showing Expanets' NorthWestern Incremental Borrowings. In each case the forecast shows a decline in the level of incremental borrowings, however, the total borrowings increase over time. This information disappears from the MFIRs in August 2002 and does not reappear at least through the November 15, 2002 transaction date. The MFIRs also contain information concerning "Funds Availability". In each MFIR that we analyzed for the period December 2001 through December 2002, according to the "Funds Availability" section there were available funds. Based upon our analysis of the MFIRs in conjunction with the statements made by management to Hanson, we have determined that, based on the MFIRs, Hanson did not
Consistent with our conclusion, during his deposition, Kindt was shown for the first time certain of the MFIRs and noted that the information was not sufficient for him to make a determination as to the cash flow of NorthWestern (Kindt June 28, 2007, page 51 to 55). In response to other questions concerning the MFIRs, Kindt made it clear that there is not enough information to make the determinations counsel was requesting him to make (Kindt June 28, 2007, page 55 to 58). 40 June 27, 2007 Deposition of Michael J. Hanson, page 120, see also pages 106, 112,116, 124 and 141.
39

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know and had no reason to know about future potential cash flow issues, alleged misstatements or alleged lack of disclosures by NorthWestern or its various subsidiaries.

3.4.2.2. Board of Directors' Information As an officer of NorthWestern, Hanson attended select Board meetings and received select information that was also provided to the Board. We have analyzed this information in two sections. Section 1 includes information that was presented to Hanson at the November 2002 Board of Directors' Meeting, including Hanson's notes made at the meeting. Section 2 includes information that was presented at the remaining Board meetings, as well as information that Hanson may have received since we cannot be sure if Hanson had an opportunity to review this information, even if he were not at the meeting. We have examined the underlying board of directors' information to determine what Hanson knew or should have known regarding the financial condition of NorthWestern including its subsidiaries Expanets and Blue Dot. · November 2002 Board Meeting

The November 6, 2002 Board meeting was the last Board meeting that Hanson attended prior to executing the required November 15, 2002 transaction documents as mandated by the sole member and manager, NorthWestern. As such, it would have formed the most up to date basis of his knowledge concerning the financial condition of NorthWestern. Hanson's notes from the November 6, 2002 Board Meeting included the following concerning Expanets: · · · Continuing problems with Expert Economy ­ Cost deferring projects Expense control has helped

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· · · · · ·

COGS have not changes drastically as % of Rev., but GM have improved (40%) ­ sustainable @ 43-44% Cash collections now strong (last 2 weeks) ­ bills now accurate DSO coming down Greater efficiency of A/E's? not spending as much time collecting & handling customer complaints. John is confident in $20m Quarterly EBITDA could be as high as $27M Has seen uptick in site contracts this year ­ better rev. this yr ­ will show up in future years. Plus GM % stronger (65%) vs. 45%) ­ Therefore get uplift in product mix

·

Normalized Revenue excluding billing problems, etc. was about 65 M/mo in 02 ­ 03 have to get to $73 M/mo -11% growth, if business stabilizes would do $23M/Q EBITDA $92 M annual

Hanson's notes from the Board Meeting included the following concerning Blue Dot: · · · Rely on "field" to budget and FCST Revenue budget built 1st ­ "Negotiated w/field to finalize Don used Alix Partner initiatives to build overall budget ­ then had field build their budgets ­ Had to `pull them back' b/c came in higher than He and Alix proposed ­ don't have higher degree of confidence they can hit #'s. · Doesn't have visibility into local operations b/c has no systems to do that Budgeting, tracking, & reporting done locally. During the board meeting, Kipp D. Orme ("Orme")41 indicated that anticipated 2002 earnings per share (EPS) were going to be reduced. Although EPS was declining, NorthWestern was still forecasting positive EPS. NorthWestern was profitable. Orme also indicated: Positive EPS would indicate that

41

NorthWestern's Chief Financial Officer

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CONFIDENTIAL, SUBJECT TO PROVISIONS OF CONFIDENTIALITY AGREEMENT "As discussed and demonstrated in the `Base Level' Liquidity/Financing sheet on page 4 of the Liquidity/Financing section of the Board package, the liquidity provided by the base operating plan is not sufficient absent further financing and/or other liquidity enhancement action. To that end, page 5 and 6 denote current opportunities that are being aggressively pursued to enhance our liquidity position."42

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At the meeting Hanson was presented with budget information for 2003 as well as forecasted information through 2006. This information indicated that NorthWestern was going to continue to be profitable and that it had enough cash flows from operations to make significant principal repayments on its debts. Furthermore, the forecasted information anticipated improving results at both Expanets and Blue Dot. Based upon the November 2002 Board materials we analyzed, including the positive plans and statements shown above, we have determined that Hanson did not know and had no reason to know about future potential cash flow issues, alleged misstatements or alleged lack of disclosures by NorthWestern or its various subsidiaries. · Other Board Meeting Information

We analyzed the other board meeting information for 2002 (similar to the data contained in the November 2002 package above) that Hanson received or may have received. Based upon the materials we analyzed, we have determined that Hanson did not know and had no reason to know about future potential cash flow issues, alleged misstatements or alleged lack of disclosures by NorthWestern or its various subsidiaries.

3.4.2.3. NCS Audit Report Hanson was the CEO of NorthWestern Services Group ("NSG"), of which NCS was an operating division. In approximately May 2002, NorthWestern decided to transfer NCS from NSG to Expanets and began to conduct due diligence. During the course of their review, Expanets noted what appeared to be financial misstatements. As a result, Hanson requested an audit of NCS' financial statements be conducted by NorthWestern's internal
42

October 30, 2002 Memorandum of Orme, NOR045248 ­ 50.

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audit group. On September 6, 2002, Audit Services released an audit report detailing their findings concerning NCS' financials, including issues regarding recognition of revenue, inventory and goodwill. The misstatements were material to NCS, however, NCS was considered to be "a very insignificant piece of the business"43 of NorthWestern.44 As the CEO of NSG, Hanson performed his duty in calling for the review of NCS' financials. This review occurred in July 2002.45 Moreover, the problems identified with the NCS financials were insignificant in relation to NorthWestern's operations as a whole. We understand that the adjustments were recorded upon completion of the internal audit. We also understand that Hanson was aware that "Mr. Hylland directed NWE [NorthWestern] to `push the envelop' in capitalizing expenses."46 In addition, "Mr. Hylland would state that as long as NWE's [NorthWestern's] reporting complied with Generally Accepted Accounting Principles ("GAAP"), then that was how the reporting should be done."47 Given that Hanson believed that reporting was in accordance with GAAP, the NCS audit results should not have caused Hanson to conclude that there were issues concerning the accounting and disclosures of the other subsidiaries, or that the November 15, 2002 transaction should not move forward. We note that subsequent to November 15, 2002, the SEC filed complaints against five individuals in connection with activities at NCS. Hanson was not one of those

43 44

Deposition of Kendall Kliewer, taken June 29, 2007, pages 224 through 229. We understand that the SEC has alleged that the misstatements were material, however the United States District Court for the District of South Dakota, Southern Division ruled in CV 06-4253 that Bart Theilbar's contention that the amounts were not material is correct. We understand that the SEC is seeking to amend the complaint in that matter. 45 According to the Association of Certified Fraud Examiners, "tips were the most common means by which occupational fraud was detected... and the majority of tips ­ nearly two out of three ­ were received from employees." (Association of Certified Fraud Examiners, 2006 Report to the Nation on Occupational Fraud and Abuse, (Austin, TX: ACFE, 2006), page 29). 46 Michael Hanson's April 10, 2003 Declaration to Paul Hastings Janofsky & Walker LLP. 47 Michael Hanson's April 10, 2003 Declaration to Paul Hastings Janofsky & Walker LLP.

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individuals. Four of those individuals entered into final judgments.48 We understand that Bart Thielbar is still contesting the SEC allegations.

3.4.2.4. Board Questions Concerning Lewis and Hylland In or around November 2002, Gary Drook49 ("Drook"), a member of the NorthWestern Board of Directors ("Board") requested that Hanson conduct an investigation concerning personal items being expensed to NorthWestern by senior officers, Lewis, Hylland, and possibly others. It appears that Hanson's involvement in the investigation was completed prior to November 15, 2002. Sometime around November 5th or 6th of 2002, Drook indicated that the Board would take the investigation from there.50 Hanson's investigation revealed that there was some credibility with respect to certain of the allegations, but that "the majority of the items were either misperceptions or not founded with the possible exception of the wine, the Dom Perignon."51 Hanson was not asked to investigate further, and did not have any indication from this limited investigation that the financial statements of NorthWestern should have been restated.

3.4.2.5. Request for Bonus Compensation We note that Hanson and Jacobsen authored a memorandum to Lewis, Hylland and John Van Camp, requesting bonus compensation based upon their involvement in the acquisition of the Montana utility business. In the memorandum, Hanson and Jacobsen discuss the historical financial performance of Expanets for the year ended December 31, 2001 and the effect that Expanets had on NorthWestern's liquidity during the last half of 2001.52 These results were not strong, but as of November 15, 2002, this information would have been almost a year old. NorthWestern had gone through several placements
48

We understand the final judgments were entered without the defendants admitting or denying the allegations of the Complaint (except as to jurisdiction), but with the waiver of findings of fact and conclusions of law, and any right to appeal from the final judgments. 49 Drook became Chief Executive Officer in January 2003. 50 June 27, 2007 Deposition of Michael J. Hanson, pages 190 to 217. 51 June 27, 2007 Deposition of Michael J. Hanson, page 213. 52 June 27, 2007 Deposition of Michael J. Hanson, pages 103 to 112.

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of debt and equity since then. As we noted in our analysis of the November 2002 Board meeting information, more recent information concerning operating performance would have been more relevant to Hanson in evaluating the November 15, 2002 transaction. Therefore the fact that Hanson knew about poor historical performance of a subsidiary would not provide Hanson with knowledge about future potential cash flow issues, alleged misstatements or alleged lack of disclosures by NorthWestern or its various subsidiaries.

3.4.2.6. Summary Hanson had more information concerning the results of operations of NorthWestern's other operations and subsidiaries then did Kindt. While there was information that may have caused some concern on the part of Hanson, other members of management, either superiors or persons directly involved in the management of those operations, indicated that the issues were going to be resolved in short order and that the company would meet their going forward plan. Therefore, it is our opinion within a reasonable degree of professional certainty that Hanson did not know and had no reason to know about future potential cash flow issues, alleged misstatements or alleged lack of disclosures by NorthWestern or its various subsidiaries. As such it was perfectly reasonable and within prudent business judgment for Hanson53 to execute the required November 15, 2002 transaction documents as mandated by the sole member and manager, NorthWestern. 3.4.3. Plaintiff's Analysis Plaintiff puts forward two experts in this matter. Assuming for the moment that Hanson and Kindt needed to perform any analysis prior to closing on the November 15, 2002 transaction (a proposition with which we disagree), Marcus is the only expert for the Plaintiff that performs any analysis that the Plaintiff suggests should have been
53

We have previously concluded that it was it was perfectly reasonable and within prudent business judgment for Kindt to execute the required November 15, 2002 transaction documents as mandated by the sole member and manager, NorthWestern.

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performed by Hanson or Kindt.54 As we will see later on in this report, the conclusions of Plaintiff's experts are speculative and have numerous flaws (the most significant of which is that there is no linkage to Hanson and Kindt). Further, assuming for the sake of argument that the Plaintiff's experts are correct and that the analysis performed by those experts is the appropriate analysis (propositions which with we disagree), Marcus is "a professional with over twenty years of experience in corporate finance, mergers and acquisitions, valuation, financial analysis, and advising on complex financial transactions. [He holds] an M.B.A. from the University of Chicago and a B.S. from Tufts University. [He also holds] the Chartered Financial Analysts designation granted by the CFA Institute and successfully completed a formal credit training program at Bank of America." Clearly Marcus has more financial analysis experience than the average prudent business person, including Hanson or Kindt, yet Marcus needed to rely on the conclusions of a Certified Fraud Examiner and Certified Public Accountant so much so that if the assumptions of Berliner prove to be incorrect, Marcus' report is not reliable and/or relevant. 3.5. INTERNAL AND EXTERNAL INVESTIGATIONS OF NORTHWESTERN There were various investigations conducted concerning the activities of the officers of NorthWestern, specifically regarding their conduct and the improper reporting that eventually lead to the restatement of NorthWestern's financial statements. We have structured this section of the report as follows: · · · Board of Directors Investigations Gibson Dunn Investigation SEC Activities

54

As noted earlier, we have not seen any analysis concerning the solvency of NorthWestern as of November 15, 2002.

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3.5.1. Board of Directors Investigations As noted above, in or around November 2002, Drook, a member of the NorthWestern Board requested that Hanson conduct an investigation concerning personal items being expensed to NorthWestern by senior officers, Hylland and Lewis. Subsequently, the Board of Directors conducted an additional or continued investigation. At a Special Meeting of the Board, on February 18, 2003, the Board created a "Special Committee" to: · · · Evaluate Hylland's performance and conduct in connection with his management of NorthWestern and its subsidiaries. To make detailed findings. To recommend to the Board the appropriate action, if any, to be taken with respect to the evaluated conduct. Kindt is not even mentioned in the report by the Special Committee. During the course of the Special Committee's investigation, Hanson was interviewed.55 Although, Hanson is mentioned in the Special Committee's report, his mention does not indicate or imply that he would know or have reason to know about future potential cash flow issues, alleged misstatements or alleged lack of disclosures by NorthWestern or its various subsidiaries. As such it was perfectly reasonable and within prudent business judgment for both Hanson and Kindt to execute the required November 15, 2002 transaction documents as mandated by the sole member and manager, NorthWestern. 3.5.2. Gibson Dunn Investigation NorthWestern's Board engaged Gibson Dunn to perform an investigation into Expanets accounting and disclosure issues in 2002. The scope included:
55

Kindt was not interviewed by the Special Committee.

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· · · ·

Expert system impacts on integrity of financial statements; internal control issues. Timing/materiality of accounting concerns Disclosure process NorthWestern and Expanets management involvement

Neither Hanson nor Kindt were interviewed as part of the investigation, demonstrating their lack of knowledge or potential involvement in the alleged scheme. 3.5.3. SEC Activities Finally, we understand that the SEC conducted an investigation into the operations of NorthWestern and its subsidiaries, the result of which was the imposition of a Cease-andDesist Order dated March 7, 2007 ("Cease-and-Desist Order").56 Also in connection with its investigation, the SEC brought legal actions against at least 11 individuals employed by NorthWestern and its subsidiaries, including the following: · · · · · Merle Lewis, former Chairman of the Board and CEO of NorthWestern Kipp Orme, former CFO of NorthWestern Richard Hylland, former COO of NorthWestern Kurt Whitesel, former controller of NorthWestern Richard Fresia, former CFO of Expanets

Neither Hanson nor Kindt were charged in connection with this investigation, demonstrating their lack of involvement in the alleged scheme.

56

Order Instituting Cease-and-Desist Proceedings, Making Findings and Imposing a Cease-and-Desist Order Pursuant to Section 21C of the Securities Exchange Act of 1934, dated March 7, 2007.

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3.6. OBSERVATIONS CONCERNING THE BERLINER AND MARCUS REPORTS 3.6.1. Observations Concerning the Berliner Report The first opinion57 offered by Berliner is an adoption of the restated financial statements that were contained in filings with the SEC. Berliner does not specify that Hanson or Kindt were included in the members of management that knew that the financials as originally filed were incorrect. As a result, Berliner's first opinion does not address whether Hanson or Kindt breached their fiduciary duty and is therefore not relevant. The second opinion58 offered by Berliner is that certain adjustments should have been made to the restated financials that were not made. Similar to Berliner's first opinion, Berliner does not specify that Hanson or Kindt were included in the members of management that knew that the financials as originally filed were incorrect. As a result, Berliner's second opinion does not address whether Hanson or Kindt breached their fiduciary duty and is therefore not relevant. Moreover, the second opinion contains methodological flaws and is speculative and without proper basis. Berliner claims that NorthWestern improperly accounted for liability reserves and other accruals at Expanets. This claim is based upon the Cease-and-Desist Order dated March 7, 2007, which does not provide sufficient information for Berliner to determine if further adjustments to the restated financial statements are warranted. As a result, Berliner's adjustment is speculative and cannot be stated within a reasonable degree of professional certainty. Berliner knows he is just guessing, as is shown in the following description in his report:

57 58

Expert Report of Robert W. Berliner, CPA, CFE, dated September 19, 2007 ­ page 1-1. Expert Report of Robert W. Berliner, CPA, CFE, dated September 19, 2007 ­ page 2-1.

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CONFIDENTIAL, SUBJECT TO PROVISIONS OF CONFIDENTIALITY AGREEMENT "For each of the three quarters, NW's Form 10-Q/A Amendment No. 2 does not provide sufficient disclosure to enable a reader to understand the amount of Expanets' income derived from the reserve reductions, or how the reserve reductions complied with FAS 5 and FIN 14. Therefore, I was unable to quantify the exact amount of Expanets' reserve reversals that were not in compliance with GAAP. For this reason, I included the entire amounts identified in the SEC's Cease-and-Desist Order less the portions thereof restated by NW as adjustments to the revised financial statements presented in Attachments A-1 through A-10."59

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Berliner's analysis is pure conjecture based upon hindsight. Berliner knows or should have known that his guess was without basis and made purely to bolster the Plaintiff's arguments. Berliner's speculation is highly objectionable and demonstrates bias rather than presenting an opinion that will assist the trier of fact. Furthermore, Berliner in essence inappropriately accuses Deloitte and Touche ("D&T")60 of incompetence in their restatement of the financial statements based only on his own speculation. their work on NorthWestern's financial statements or the restatements. Berliner then makes an adjustment to record an impairment charge against goodwill in the amount of $390,000,000.61 The adjustment to goodwill is in essence a valuation adjustment. As such, it is an adjustment that is based upon what is known or knowable at the time of the adjustment. Berliner's adjustment is based on hindsight, violating this basic premise of developing a value based upon information that was known or knowable at the time. D&T completed the NorthWestern audit for the year ended December 31, 2002. During the same period, D&T oversaw the restatements made to the Forms 10-Q for the periods ended March 31, 2002, June 30, 2002 and September 30, 2002. The December 31, 2002 financials and the restatements were filed with the SEC on the same day. D&T made an