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Fifth Circuit: Investment Banks Owed No Duty to Enron Shareholders
Under a ruling by the 5th U.S. Circuit Court of Appeals,
shareholders of Enron Corp. will be unable to recover damages from investment
banks that allegedly engaged in transactions that allowed Enron to misstate its
financial condition. Secondary actors such as investment banks and accountants
who act in concert with public companies in schemes to defraud investors cannot
be held liable as primary violators of Rule 10b-5, concluded the court, unless
they 1) directly make public misrepresentations, 2) owe the shareholders a duty
to disclose or 3) directly manipulate the market for the company's securities
through practices such as wash sales or matched orders.
At most, said the appeals court, the banks could have aided
and abetted Enron's deceit by making its misrepresentations more plausible but
their conduct did not rise to primary liability under Rule 10b-5. Under the U.S.
Supreme Court's ruling in Central Bank of Denver v. First Interstate Bank
(1993-94 CCH Dec. ¶98,178, there is no private action for secondary aiding and
abetting liability under Rule 10b-5. The investment banks owed no duty to
Enron's shareholders, emphasized the panel.
While acknowledging that the investment banks escaped
liability for alleged conduct that was "hardly praiseworthy," the
appeals court reasoned that Congress was not irrational to promote plain legal
standards for actors in the financial markets by limiting secondary liability.
In the antifraud statute, Congress is balancing competing desires to provide
some remedy for securities fraud without opening the floodgates for nearly
unlimited and frequently unpredictable liability for secondary actors in the
securities markets. And, in Central Bank, the Supreme Court was seeking
certainty through strict construction of Section 10(b) against inputting aiding
and abetting liability for secondary actors under the rubric of deceptive acts
or schemes.
The district court held that the presumption of reliance
applied because the facts indicated that the banks had failed in their duty not
to engage in a fraudulent scheme. The court determined that a deceptive act
within the meaning of Rule 10b-5(c) includes participating in a transaction
whose principal purpose and effect is to create a false appearance of revenues.
The appeals court addressed only the definition of a
"deceptive act," because it was dispositive of the appeal, and not the
district court's scheme liability holding. The appeals court held that the
district court's conception of deceptive act liability is inconsistent with the
Supreme Court's decision that Section 10 does not give rise to aiding and
abetting liability. An act cannot be deceptive within the meaning of Section
10(b) where the actor has no duty to disclose. Presuming the allegations to be
true, Enron committed fraud by misstating its accounts, but the banks only aided
an abetted that fraud by engaging in transactions to make it more plausible. The
investment banks owed no duty to Enron's shareholders, said the appeals court.
Presuming the allegations to be true, Enron committed fraud
by misstating its accounts, but the banks only aided an abetted that fraud by
engaging in transactions to make it more plausible. The investment banks owed no
duty to Enron's shareholders, said the appeals court. In order to be true to the
Supreme Court's concerns when it ruled that Section 10(b) does not give rise to
aiding and abetting liability, noted the appeals panel, it is essential to
ensure that lower courts do not misapply aiding and abetting liability under the
guise of primary liability through an overly- broad definition of deceptive
acts.
In a concurring opinion, Judge Dennis said that the Fifth
Circuit has now aligned itself with the Eighth Circuit and immunizes a broad
array of undeniably fraudulent conduct from civil liability under Rule 10b-5,
effectively giving secondary actors license to scheme with impunity, as long as
they keep quiet. He described the majority's interpretation of the statutory
language of Section 10(b) as "cramped," but concluded that the
district court erred by construing too broadly the joint and several liability
provision of the Private Securities Litigation Reform Act.
Regents of the University of California v. Credit
Suisse First Boston (USA), Inc. (5thCir) is reported at ¶94,173.
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