Analysis: Impetus from an Enron ruling?
on Mar 20, 2007 at 10:53 pm
The Fifth Circuit Court’s sweeping ruling Monday on securities fraud, perhaps frustrating investors’ claims for up to $40 billion in damages out of the Enron scandal, adds a new layer of significance to two appeals that the Supreme Court will be considering at its private Conference on Friday. The new case brought by Enron shareholders is on its way to the Supreme Court, lawyers have said, but the Justices may well act first on the cases already there and focusing on the same legal question..
The Fifth Circuit decision in Regents of the University of California, et al., v. Credit Suisse First Boston, et al. (Circuit docket 06-20856) deepens a Circuit Court split, and thus provides some added reason for the Court to take on the question of third parties’ liability for securities fraud committed by others. That is the issue the Justices have been examining in Stoneridge Investment Partners v. Scientific Atlanta (Supreme Court docket 06-43) and Avis Budget Group, et al., v. California State Teachers Retirement System (06-560). The Court considered those cases at last Friday’s Conference, but took no action, and is due to take another look this Friday, according to the Court’s electronic docket.
While some early news accounts of the Fifth Circuit ruling in the California Regents case have emphasized the facet of that ruling barring the use of class-action procedure, of equal if not greater importance was the Circuit Court’s conclusions about the merits of investors’ claims against major banks and prominent brokerage firms. In reaching its decision on that point of federal securities fraud law, the Circuit Court aligned itself with the Eighth Circuit (whose ruling is at issue in 06-43) and against the views of the Ninth Circuit (in 06-560).
Relying on the Supreme Court’s 1994 ruling in Central Bank v. First Interstate Bank, barring private securities fraud claims based on assertions of aiding and abetting deception, the Fifth Circuit ruled that banks and brokerage firms cannot be held liable for their alleged role in Enron Corp,’s actions in taking liabilities off of its books temporarily and treating what was actually debt as if it were revenue, thus misstating its financial condition and misleading investors. The deception inflated Enron’s stock prices and enriched Enron executives.
With Enron collapsed by revelations of the scheme and government prosecutions, the banks and brokerage firms are attractive alternative targets. In fact, investors already have won $7.3 billion in settlements from others who were sued who made a deal to avoid the risks of the litigation — risks that were enhanced by the class-action procedure that a federal judge in Houston had authorized last June. In the wake of the Fifth Circuit ruling, the remaining class claims against Credit Suisse, Barclays Bank and Merrill Lynch were put on hold Tuesday by the judge, Melinda Harmon. Those other claims seek $40 billion in damages — less the $7.3 billion already paid in settlements.
In reaching its conclusion that a class should not have been certified, the Fifth Circuit said it was obliged to rule on some aspects of the merits of the underlying case. In doing so, it found that the banks and brokerage firms had not engaged in a “deceptive act” under securities fraud law. Judge Harmon, for purposes of identifying the legal issues, had defined that phrase broadly, as has the Ninth Circuit. “The district court’s definition of ‘deceptive act’ is integral to its conclusion that the requirements for class certification are met,” the Fifth Circuit said Monday.
Judge Harmon had certified a class of all investors who bought Enron stock between Oct. 19, 1998, and Nov. 27, 2001, and suffered injury from the company’s financial manipulations.
The Fifth Circuit said that the “banks [and brokerage firms) owed no duty to the [investors] other than the general duty not to engage in fraudulent schemes or acts (that is, the duty not to break the law).” Thus, it concluded, investors could not have relied upon the banks and brokers’ failure to disclose publicly the nature of the Enron scheme in which they allegedly took part.
“Presuming [investors’] allegations to be true, Enron committed fraud by misstating its accounts,” the Circuit Court said, “but the banks only aided and abetted that fraud by engaging in transactions to make it more plausible; they owed no duty to Enron’s shareholders….The district court’s conception of ‘deceptive act’ liability is inconsistent with the Supreme Court’s decision [in the Central Bank case] that Section 10 [the securities fraud provision] does not give rise to aiding and abetting liability.”
Making third parties liable in the circumstance in this case, the Circuit Court said, “gives rise to confusion about the extent of secondary actors’ obligations and invites vague and conflicting standards of proof in divers courts.”
The Circuit Court also seemed much troubled that certifying a class in this case would add inappropriate pressure for settlement of the remaining shareholdlers’ claims. “Class certification,” it said, “may be the backbreaking decision that places insurmoutnable pressure on a defendant to settle, even where the defendant has a good chance of succeeding on the merits.”
While the Fifth Circuit, in choosing to follow the Eighth rather than the Ninth Circuit, did add to the conflict among the appeals courts, there is a chance that the Supreme Court could be persuaded in the pending Ninth Circuit case (06-560) that the conflict has lost some of its importance because that case might now be moot. After the Ninth Circuit ruling, the District Court in that case refused to allow an amended complaint and dismissed all those who are appealing to the Supreme Court. The other side thus contends that there is no case pending against those pursuing the appeal. The petitioners, however, dispute that the case is moot, saying they have appealed the District Court’s action and arguing that the controversy remains very much alive over whether they could be held liable. The petitioners note that they would not be held liable under the conflicting view of the Eighth Circuit in case 06-43.
