The SEC, the Supreme Court, and Enron

This post is by J. Robert Brown, Jr. of the University of Denver Sturm College of Law.

The Wall Street Journal carried a story yesterday on the pressure building on the SEC to file an amicus brief supporting the petition for certiorari filed by the plaintiffs in the Enron securities litigation against the firm’s former financial advisors.  In Regents of the University of California v. Credit Suisse, the Fifth Circuit reversed the certification of a class bringing securities claims against investment banking firms that worked with Enron, holding that Section 10(b) does not provide for primary liability for such advisors and deepening the split among the federal appellate courts on that issue.

The Supreme Court has already agreed to decide whether financial advisors may be liable under Section 10(b) in Stoneridge Investment Partners v. Scientific Atlanta, an appeal from the Eighth Circuit, and The Race to the Bottom Blog will explore the issues raised by these cases next week.  But there is a crucial–and largely overlooked–difference between Stoneridge and the Enron litigation that may well affect the outcome.  It concerns the makeup of the justices who will be deciding the case.  If the Court grants review in the Enron litigation as well, it may well tell us something about the likely outcome in Stoneridge itself.

Liability of a financial advisor or vendor under Section 10(b) depends upon whether their conduct constitutes a “deceptive act.”  In 1994, the Supreme Court in Central Bank v. First Interstate Bank held that the language of Section 10(b) did not extend to aiding and abetting liability.  The Fifth and Eighth Circuits have held that vendors and financial advisors (like the investment bankers that assisted Enron) only aid and abet securities violations (unless the advisors have an independent duty to disclose, which they usually do not), and thus cannot be held primarily liable under Section 10(b).  In contrast, the Ninth Circuit has held that a vendor’s conduct might still constitute a “deceptive act,” at least where the purpose and effect of the vendor’s conduct was to cause securities fraud.

Crucially, the Supreme Court’s order granting certiorari in Stoneridge indicates that two justices (The Chief Justice and Justice Breyer) did not participate; those two Justices are therefore likely to be conflicted out of the case.  (The Justices’ financial disclosure forms indicate that they may hold stock in parties to the litigation.)  Of the remaining seven justices, three (Justices Scalia, Kennedy, and Thomas) voted to eliminate aiding and abetting liability under Section 10(b) as members of the Central Bank majority.  Three others (Justices Stevens, Souter, and Ginsburg) dissented in Central Bank.  The votes in Central Bank–a decision that, as Justice Stevens noted in dissent, was contrary to the previous rulings of every circuit to have considered the issue–may be an appropriate means of determining how the Justices will view Stoneridge.  And, to the extent the justices’ votes in Central Bank are indicative of their views in Stoneridge, it will be the Court’s newest Member, Justice Samuel A. Alito, who will determine the outcome.

While a judge on the Third Circuit, Justice Alito’s opinions evinced a workmanlike approach to securities fraud cases.  He authored three decisions on securities fraud, twice reversing dismissals of shareholder suits on the pleadings.  In In re Westinghouse Sec. Litigation, decided in 1996, then-Judge Alito permitted shareholders to proceed with a suit against officers and directors, but held that the shareholders’ claims against Price Waterhouse, the company’s accountants, were meritless as a matter of law.  In In re Burlington Coat Factory Sec. Litigation, decided the following year, Justice Alito again vacated a dismissal of a shareholder suit, holding that the plaintiffs had plead the alleged fraud with sufficient particularity to meet the requirements of Federal Rule of Civil Procedure 9.  And in Oran v. Stafford, decided in 2000, Justice Alito wrote an opinion affirming the dismissal of a 10(b) suit, holding that the plaintiffs had failed to plead that the defendants made a material misrepresentation of fact.

These cases do not suggest that Justice Alito is predisposed to limit the reach of Section 10(b).  Justice Alito could, therefore, vote for a more expansive interpretation of primary liability–one that captures the conduct of financial advisors and vendors–than the one used by the Eighth Circuit in Stoneridge and the Fifth Circuit in Credit Suisse.  On the other hand, if Justice Alito can be persuaded to join the three participating members of the Central Bank majority, the Court will affirm the Eighth Circuit, holding that financial advisors cannot be held primarily liable under Section 10(b).

But if the Court also grants review in Credit Suisse, it probably tells us something about the outcome in Stoneridge.  Presumably The Chief Justice and Justice Breyer will not be recused.  Justice Breyer seems unlikely to adopt a constricted view of Section 10(b).  Although he authored Dura Pharmaceuticals v. Broudoa case that restricted the application of Section 10(b) by holding that a mere allegation of loss causation is not enough to survive a motion to dismiss, the decision was unanimous and thus does not tell us much about Justice Breyer’s views in a closer securities case.  Moreover, Justice Breyer also penned The Wharf Ltd. v. United International Holdings (another unanimous opinion), adopting a broad interpretation of the “in connection with” requirement under Section 10(b).  Most importantly, Justice Breyer joined the majority in United States v. O’Hagan, upholding the doctrinally suspect but necessary misappropriation theory of insider trading.  Justice Breyer will, therefore, mostly likely be a fourth vote to reverse the narrow interpretation of primary liability for financial advisors and vendors given by the Eighth and Fifth Circuits.

Chief Justice Roberts, on the other hand, has little track record in securities cases.  Before joining the bench, however, he had an extensive corporate practice, and is considered a “pro-business” judge who may be disinclined to expand the reach of Section 10(b).  Moreover, Chief Justice Roberts and Justice Alito are ideologically associated with Justices Thomas and Scalia, both members of the Central Bank majority.  The four voted together yesterday, for example, in a case involving gender discrimination in employment.

Predictions at this stage are very difficult to make–the Supreme Court hasn’t granted review in the Fifth Circuit Enron litigation, and merits briefs have not yet been filed in Stoneridge.  Nonetheless, if the Court grants review in Credit Suisse, it could well mean that Chief Justice Roberts and Justice Alito are inclined to take a narrow view of primary liability, and that The Chief Justice will be in a position to assign the opinion to a wavering Justice Alito.  If Credit Suisse is granted, look for the case to be a 5-4 decision, with liability under Section 10(b) not extended to vendors and investment bankers, even where they know the transaction is a sham and will be used to effect a financial fraud.

Both comments and trackbacks are currently closed.


  1. Joseph Feldman
    Posted Tuesday, October 9, 2007 at 5:12 am | Permalink

    The Stoneridge case is critical. Investment banks, banks, lawyers, and accountants must be permitted to collude with issuers of financial statements to perpetrate frauds without interference by annoying law firms from the plaintiffs’ bar. Such third parties depend upon the revenues they earn from participating in creating, developing, and marketing such fraud schemes to issuers and it would be a violation of the rights to impinge on the furtherance of their important services. Indeed, an economic collapse could well result of such proportions and magnitude if any cap is placed on such activities that even the puny SEC fines that are sometimes imposed could alse adversely affect operations leading to a complete implosion of the free market. I am certain that the US Supreme Court understands the importance of this case and will decide to ignore the law as it is written and to interpret it to fit a scope which not only eliminates third party scheme liability, but also encourages third parties to engage in such frauds even if they had not considered doing so in the past. Thank you.

  2. Steve
    Posted Thursday, March 5, 2009 at 6:15 pm | Permalink

    Just to further update the article here is some current information. New York, January 23, 2008—The United States Supreme Court has declined to hear an appeal of the victory secured by Shearman & Sterling litigators before the United States Court of Appeals for the Fifth Circuit on behalf of Merrill Lynch with respect to Enron. The Fifth Circuit decision reversed a district court’s order certifying a class of Enron investors who were seeking $40 billion in damages from the defendants.

    Today’s victory before the Supreme Court follows closely in the wake of the United States Supreme Court’s recent decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. that rejected “scheme” liability as a means of expanding the scope of primary liability under the federal securities laws to sweep in a new class of defendants who do business with companies that are later found to have misrepresented their financial condition. Shearman & Sterling litigators submitted an amici curiae brief in the Stoneridge case on behalf of the Organization for International Investment, International Chamber of Commerce, and Federation of German Industries. In its opinion, the Supreme Court relied on Shearman & Sterling’s brief, explaining that the Court rejected “scheme” liability because, among other things, to hold otherwise would mean that “[o]verseas firms with no other exposure to our securities laws could be deterred from doing business here.”

    These firms needed to use to find a comprehensive listing of high quality financial advisors.

  3. Steve Hirsch
    Posted Monday, June 1, 2009 at 4:41 pm | Permalink

    Is this the classic tug-of-war between business interests and consumer protection? Business interest seems to be on a long winning streak.

    Steve Hirsch
    All Advertising Agencies

  4. Lance
    Posted Saturday, August 14, 2010 at 10:57 pm | Permalink

    To me it’s not a matter of business interest versus consumer protection rather it’s simply a matter of doing the right thing. How difficult can it be to determine if the “vendors” knew what was up. They knew what was going on which is more than mere aiding and abetting.

    (c) [t]o engage in any act, practice, or course of
    business which operates . . . as a fraud or deceit upon any person, in connection with the
    purchase or sale of any security.”

    The question is would a prudent and reasonable entity be in a position to know that fraud was being committed? I suspect that they did.

  5. Financial capital
    Posted Wednesday, September 8, 2010 at 6:10 pm | Permalink

    Indeed, an economic collapse could well result of such proportions and magnitude if any cap is placed on such activities that even the puny SEC fines that are sometimes imposed could alse adversely affect operations leading to a complete implosion of the free market.

  6. Financial Planner Massachusetts
    Posted Tuesday, March 12, 2013 at 11:03 am | Permalink

    Economic collapse will never happen. Enrons will always happen. You can’t regulate away Enrons. It’s how the system works – flushes out the waste and moves forward… The issues of today may seem large, but in hindsight, they’ll be a blip compared to what we face in our tomorrow…