Category Archives: Enron
While The 10b-5 Daily was on break last week, there were interesting developments in two of the biggest ongoing securities litigations.
(1) On Friday, the U.S. Court of Appeals declined to reconsider its class certification decision in the IPO allocation cases.
Quote of note (ruling): “The Petitioners, having sought a broad class, are essentially complaining that we failed to narrow their class definition to an extent that might have satisfied Rule 23 requirements. Whatever authority we might have had to undertake that task, we did not think it appropriate to provide legal advice to experienced class-action litigators.”
(2) Meanwhile, the plaintiffs in the Enron securities class action are attempting to appeal the denial of class certification by the U.S. Court of Appeals for the Fifth Circuit related to their claims against Enron’s banks. A cert petition (via WSJ) was filed with the U.S. Supreme Court on Thursday. Among other things, the petition argues that the case is a “suitable companion” to the Charter Communications case the Court will hear next term. The media coverage includes articles by the Associated Press and Houston Chronicle.
Quote of note (cert petition): “This case is especially significant because it involves the alleged misconduct of banks – major actors in our nation’s financial markets and the banks that Central Bank identified as secondary actors who nonetheless ‘may be potentially liable as primary violators under Rule 10b-5 in any complex securities fraud [where] there are likely to be multiple violators.'”
In two decisions issued last year, the Eighth Circuit and the Ninth Circuit split over the extent to which secondary actors (e.g., accountants, lawyers, or bankers) can be held primarily liable under Rules 10b-5(a) and (c) for deceptive devices, schemes, and acts. The Eighth Circuit limited the scope of potential liability, holding that “any defendant who does not make or affirmatively cause to be made a fraudulent misstatement or omission, or who does not directly engage in manipulative securities trading practices, is at most guilty of aiding and abetting and cannot be held liable under Sec. 10(b) or any subpart of Rule 10b-5.” In contrast, the Ninth Circuit created a broader test, finding that “to be liable as a primary violator of Sec. 10(b) for participation in a ‘scheme to defraud,’ the defendant must have engaged in conduct that had the principal purpose and effect of creating a false appearance of fact in furtherance of the scheme.” In a decision issued yesterday, the Fifth Circuit has sided squarely with the Eighth Circuit and limited the scope of liability.
In Regents of the Univ. of California., et al. v. Credit Suisse First Boston (USA), Inc., et al., 2007 WL 816518 (5th Cir. March 19, 2007), the issue presented was whether the district court had properly granted class certification for Rule 10b-5 claims brought against three banks that had entered into transactions with Enron. The “common feature of these transactions is that they allowed Enron to misstate its financial condition; there is no allegation that the banks were fiduciaries of the plaintiffs [Enron investors], that they improperly filed financial reports on Enron’s behalf, or that they engaged in wash sales or other manipulative activities directly in the market for Enron securities.” Nevertheless, the district court held that class certification was appropriate because a “deceptive act” included participation in a transaction whose principal purpose and effect was to create a false appearance of revenues. Because the banks had failed in their duty not to engage in a fraudulent scheme, the district court found that plaintiffs were “entitled to rely on the classwide presumption of reliance for omissions and fraud on the market.” On appeal, the Fifth Circuit disagreed.
As an initial matter, the court found that it could address the district court’s definition of “deceptive act” because it was the basis for the district court’s determination that the plaintiffs were entitled to a presumption of reliance. Without that presumption, class certification would fail.
The court then turned to whether plaintiffs could properly rely on a presumption of reliance created by either the existence of actionable omissions or a fraud on the market. First, the court held that the banks had not made any actionable omissions because they “did not owe plaintiffs any duty to disclose the nature of the alleged transactions.” Second, the court found that the district court’s definition of “deceptive act” was “inconsistent with the Supreme Court’s decision that Sec. 10 does not give rise to aiding and abetting liability.” After examining relevant Supreme Court precedent, the court held that the Eighth Circuit’s definition of “deceptive act” (i.e., conduct involving “either a misstatement or a failure to disclose by one who has a duty to disclose”) was correct. In contrast, the banks’ acts “at most aided and abetted Enron’s deceit by making its misrepresentations more plausible.” Finally, the court concluded that the transactions did not constitute market manipulation because the banks “did not act directly in the market for Enron securities.” Because the banks’ transactions with Enron were not deceptive acts and did not constitute market manipulation, there could be no fraud on the market presumption of reliance and class certification failed.
A few additional notes on the panel’s decision:
(1) There is a “concurrence” that, in fact, is a vigorous dissent from the primary legal holdings in the majority opinion. In particular, the concurring judge found that the majority had overreached in deciding the substantive scope of Rule 10b-5 on an appeal from class certification and that its definition of “deceptive act” was too narrow.
(2) There has been a significant amount of commentary on the decision already. For an internet roundup, see this Point of Law post.
(3) One obvious question is whether this ruling will have any effect on the previous bank settlements in the Enron securities litigation totaling over $7 billion. According to a Wall Street Journal article in today’s edition, the answer is “no,” because the settlements are already final.
Quote of note (opinion): “We recognize, however, that our ruling on legal merit may not coincide, particularly in the minds of aggrieved former Enron shareholders who have lost billions of dollars in a fraud they allege was aided and abetted by the defendants at bar, with notions of justice and fair play. We acknowledge that the courts’ interpretation of § 10(b) could have gone in a different direction and might have established liability for the actions the banks are alleged to have undertaken. Indeed, one of our sister circuits – the Ninth – believes that it did. We have applied the Supreme Court’s guidance in ascribing a limited interpretation to the words of § 10, viewing the statute as the result of Congress’s balancing of competing desires to provide for some remedy for securities fraud without opening the floodgates for nearly unlimited and frequently unpredictable liability for secondary actors in the securities markets.”
The fee-shifting imposed by the Enron court – related to claims brought against Alliance Capital – continues to make news. At the time of the decision, the Wall Street Journal (subscrip. req’d) published an editorial lauding the result. In today’s edition, the plaintiff’s attorney fights back with a letter that he challenges the paper to print (a bet he happily loses), while the newspaper’s editorial board defends its analysis. The WSJ Law Blog has the blow-by-blow (free content).
In an unusual decision, the S.D. of Tex. has ordered that a prominent plaintiffs’ firm pay the attorneys’ fees and expenses of Alliance Capital, a money management company sued for control person liability (under Section 15 of the 1933 Act) in the Enron securities class action. The plaintiffs had alleged that Alliance controlled one of its employees who also served as an Enron outside director. In his role as an Enron director, the employee signed a registration statement for a public offering that incorporated Enron’s admittedly false financial statements for 1998-2000.
In In re Enron Corp. Securities, Derivative & “ERISA” Litigation, 2006 WL 3474980 (S.D.Tex. Nov. 30, 2006), the court found that the plaintiffs had failed to establish facts sufficient for a reasonable jury to conclude that Alliance was a control person. More interestingly, the court held that although the plaintiffs’ firm could not be held liable for all of Alliance’s fees and expenses from the outset of the case, once the director was deposed and sufficient evidence did not emerge, the plaintiffs’ firm should have dropped the claim. Accordingly, the firm was required to pay Alliance’s fees and expenses related to the summary judgment stage of the litigation.
Quote of Note: “Moreover, it appears to this Court more appropriate that an award of fees and costs under § 11(e) should be borne by counsel: non-attorney clients more likely than not would not have the ability to determine at what point, based on what evidence, an action becomes legally ‘frivolous,’ while its licensed counsel should and is held to such a standard.”
Because few securities fraud cases go to trial, courts rarely have had to address the proportionate liability scheme created by the PSLRA. In a nutshell, the PLSRA provides for proportionate liability unless the trier of fact finds that the defendant “knowingly” violated the applicable securities laws. If a defendant is only found to have engaged in a reckless violation, the trier of a fact must make “findings with respect to each covered person and each of the other persons claimed by any of the parties to have caused or contributed to the loss incurred by plaintiff” to determine the proportionate liability of the defendant in question.
In a recent decision in the Enron securities class action – In re Enron Corp. Sec., Derivative & “ERISA” Litigation, 2006 WL 1851383 (S.D. Tex. July 5, 2006) – the court found that the failure of Congress to explain or limit the clause “each of the other persons claimed by any of the parties to have caused or contributed to the loss” has the potential to wreak havoc on a trial. The “other persons” could include “non-parties to the suit, defendants that have settled, defendants that have been dismissed, and indeed even the plaintiffs.” Based on the vagueness of the statute, “defendants most likely will attempt to designate any person or entity that might conceivably have any responsibility for the plaintiffs’ loss.” Moreover, the statute does not specify what “caused” or “contributed to” means and does not establish who has the burden of proof as to the responsibility of these “other persons.”
To address these issues, the court established some significant threshold requirements for implementing the proportionate liability scheme:
(1) Any party designating a non-party as potentially responsible for the plaintiffs’ loss shall “bear the burden of proof demonstrating that the non-party violated the federal securities statutes.”
(2) If the trier of fact determines that a defendant did not violate the securities laws, there cannot be any allocation of fault to that person.
(3) All parties who wish to claim that a non-party, settling party, or dismissed party is responsible for any or all of the plaintiffs’ losses must file, prior to trial, “the name of such person or entity and provide a statement of the factual basis for claiming that fault should be allocated” to that person or entity. Moreover, the designating person must “demonstrate in that factual statement that the non-party could have been sued by plaintiffs, i.e., that the claims against it could have met requirements of the PSLRA, but was bypassed or dismissed.”
(1) The Boston Business Journal has an article on securities class action litigation trends. The article suggests that the recent rise in financial restatements may lead to a boom in filings.
(2) The Chicago Tribune provides a lengthy profile of Daniel Fischel, a law professor and leading expert witness in securities cases. Fischel will be testifying on behalf of Enron’s former CEO at his criminal trial.