Background: In 2002, shareholders who were defrauded in the Enron debacle brought a lawsuit to recover their losses. The complaint charged certain Enron executives and directors, its accountants, law firms, and banks with violations of federal securities laws. It alleged that the Enron executives and directors engaged in massive insider trading while making false and misleading statements about Enron’s financial performance. The shareholders estimate that the investors lost $40-45 billion due to this illegal behavior.
The shareholders’ complaint named several large investment banks as defendants, alleging they knowingly participated in the fraudulent scheme with Enron. The investors alleged that the banks engaged in deceptive conduct by structuring contrived financial transactions to falsify Enron’s financial statements, generating fake profits and hiding billions in debt. Internal Enron documents and testimony of bank employees detailed how the banks engineered sham transactions to keep billions of dollars of debt off Enron’s balance sheet and create the illusion of increasing earnings and operating cash flow.
The Enron shareholders have reached settlements of over $7 billion with financial institutions, including Lehman Brothers, Bank of America, Citigroup, JP Morgan Chase and Canadian Imperial Bank of Commerce. Claims were still pending against a number of additional institutions in March of this year, when a 2-1 Fifth Circuit Court of Appeals decision granted the banks complete immunity from liability to the victims.
Fifth Circuit Decision: Although the Fifth Circuit acknowledged that the banks’ conduct was “hardly praiseworthy,” they ruled that because the banks themselves did not make any “false statements” about their conduct, they could not be liable to the victims even if they knowingly participated in the scheme to defraud Enron’s shareholders.
In an extraordinary admission, the Court’s two-member majority acknowledged that their ruling runs afoul of “justice and fair play.” They stated, “We recognize, however, that our ruling … 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.”
The Fifth Circuit decision conflicts with a recent Ninth Circuit decision upholding scheme liability.
The decision also conflicts with the position of the SEC in prior amicus briefs supporting “scheme liability,” including briefs filed in the Enron case, and with the vote of the SEC to file a brief in a similar case pending before the U.S. Supreme Court entitled Stoneridge Investment Partners v. Scientific-Atlanta, Inc., et. al.
Stoneridge: Soon after the Fifth Circuit ruled in Enron, the U.S. Supreme Court granted cert in the Stoneridge case. Stoneridge is an appeal from an Eighth Circuit opinion rejecting scheme liability. The question presented in that case is the same one raised in the Enron case:
Does liability exist for participating in a scheme to defraud under section 10(b) and rule 10b-5(a) and (c), where the actors engaged in contrived financial transactions with a public corporation to distort and falsify its financial statements, but where those actors themselves made no public statements concerning those transactions?
The Enron shareholders have also petitioned the Supreme Court to accept their case on appeal. To date, the Supreme Court has not granted or denied cert in Enron. However, since the Court has accepted the Stoneridge case, one way or another, the Supreme Court will decide the “scheme liability” issue after oral argument later this year. In so doing, it will determine the ability of the Enron victims to continue their case and obtain the recovery to which they ought to be entitled.
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