Stoneridge Redux: The Enron Case (Part VI)

We are discussing the consequences of Stoneridge, focusing on the brief filed by Lead Plaintiff in the Enron case.  It contains an entirely different theory of the case.  Plaintiff contended that the investment banking firms have an independent duty to disclose.

• The evidence presented in this case creates a triable issue of fact as to whether each of the remaining bank defendants had a duty to disclose at least the facts concerning its own deceptive conduct and the effects of that conduct on Enron’s reported financial results. This duty arises from the complex, multifaceted, active participation of the Banks in the market for Enron securities and their efforts to encourage and induce investors to purchase those securities. In stark contrast to the supplier/customer defendants in Stoneridge, who had little if any contact with the Charter Communications investment community, here the Banks engaged and interacted on many levels with Enron investors and with the market. In so doing, the Banks actively sought to encourage and induce market investors to purchase Enron securities.

What is the theory for the duty to disclose?  It arises in part from a general notion that the market relied on the integrity and expertise of the investment banking firms that arose from their substantial involvement in the market for Enron shares.   

The brief also raised the possibility that the investment banks fell into the category of "temporary insider," a doctrine invented by the Supreme Court in SEC v. Dirks (n. 14) to fill gaps in its desultory approach to insider trading.  As with any insider, those with the "temporary" appellation have a duty to disclose whenever they engage in securities activities.  The brief alleges that the banks were involved in trading activities both by acting as underwriters and engaging in equity swaps and equity forwards.  As a result, the "Banks here were under an obligation to disclose their knowledge of the fraud or abstain from trading Enron's securities." 

Imposing a general duty to disclose will be a stretch, at least in the 5th Circuit, a circuit so far demonstrating considerable hostility to the imposition of liability on the investment banking firms.  At the same time, however, the brief is correct to rely on the reasoning in Stoneridge that suggests those actually involved in the securities raising process might actually have higher duties, particularly where they are benefiting financially from the alleged fraud. 

In fact, the Lead Plaintiff ought not to need such an innovative theory.  Plaintiff alleges that the investment banks engaged in deceptive conduct, something acknowledged by the Supreme Court as a basis for a fraud suit.  They are not "remote" from the securities markets but directly involved in the capital raising process.  As such, engaging in separate acts of deception in an effort to facilitate a misstatement of Enron's financial results ought to be enough.  There ought not to be a need to even argue for a duty to disclose.   

Having said that, Lead Plaintiff knows that the reasoning used by the Supreme Court is vague and derives from no meaningful legal principles.  As a result, it will be whatever a particular lower court wants it to be.  In the Fifth Circuit, it is likely that the court wants it to be a doctrine that eliminates liability for those participating in someone else's false disclosure, even when the involvement involved a separate deceptive act.  It has forced the Lead Plaintiff to argue for an independent duty to disclose by the investment banks. 

A copy of Lead Plaintiff's supplemental brief in connection with a pending motion for summary judgment is on the DU Corporate Governance web site.