Affco Investments 2001, L.L.C., et al v. KPMG, L.L.P., et al

Filing

PUBLISHED OPINION FILED. [09-20734 Affirmed] Judge: CDK , Judge: PEH , Judge: EMG. Mandate pull date is 11/17/2010 [09-20734]

Affco Investments 2001, L.L.C., et al v. KPMG, L.L.P., et al Case: 09-20734 Document: 00511276237

Page: 1 Date Filed: 10/27/2010

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IN THE UNITED STATES COURT OF APPEALS United States Court of Appeals FOR THE FIFTH CIRCUIT Fifth Circuit FILED
October 27, 2010 N o . 09-20734 Lyle W. Cayce Clerk

A F F C O INVESTMENTS 2001 LLC; AFFCO, LLC; KENNETH KEELING; L E W I S W. POWERS; JOHN H. POWERS; ALBERT GUNTHER, III; S H A N N O N ELLIS; HEIDI GUNTHER; ERIC LINQUEST; GRETCHEN L IN Q U E S T ; LA GIT 88 TRUST; POWERS CHILDREN INTER VIVOS T R U S T ; MARTHA GUNTHER, P la in t iffs - Appellants v. P R O S K A U E R ROSE L.L.P., D e fe n d a n t - Appellee

A p p e a l from the United States District Court fo r the Southern District of Texas

B e fo r e KING, HIGGINBOTHAM, and GARZA, Circuit Judges. K I N G , Circuit Judge: P la in tiffs-A p p e lla n t s invested in a complex tax avoidance scheme that was la t e r investigated and disallowed by the IRS. In the aftermath of the back taxes, in t e r e s t , and penalties that ensued, Plaintiffs sued Defendant-Appellee P r o s k a u e r Rose, L.L.P. and sixteen other defendants, asserting claims under the R a c k e te e r in g Influenced and Corrupt Organizations Act, the Securities E x c h a n g e Act of 1934, and Texas state law. The district court dismissed the r a c k e t e e r in g claim as barred under the Private Securities Litigation Reform Act

Dockets.Justia.com

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No. 09-20734 a n d dismissed the securities fraud claims for failure to sufficiently plead the e l e m e n t s of reliance and scienter. For the following reasons, we AFFIRM the d is t r ic t court's judgment. I . BACKGROUND T h is case involves a sophisticated income tax avoidance strategy in which t a x p a y e r s attempted to claim tax losses through a mechanism of offsetting d ig ita l options.1 Through a limited liability company ("LLC") created solely for t h e purpose, a taxpayer would use a brokerage firm as a counter-party to buy a n d sell nearly identical options at approximately the same prices. Having thus h e d g e d against any true losses, the taxpayer would claim a tax basis in the LLC t h a t was increased by the cost of the purchased options, but not reduced by the p r ic e received for the options sold. When the LLC later suffered a "loss" (for e x a m p le , by selling its options for their low fair-market value), the taxpayer w o u ld claim a share of that "loss" calculated according to his increased tax b a s is .2 A c c o r d in g to the amended complaint, the accounting firm of KPMG, LLP ("K P M G ") targeted and solicited Plaintiffs for participation in such a tax scheme, r e p r e s e n t in g the scheme to be a legitimate investment vehicle as well as a le g it im a t e tax shelter through which taxpayers could offset some or all of their

Digital options are option contracts in which the purchaser of the option wagers that the price of an underlying commodity, currency, or security will be above or below a certain "strike price" at a particular point in time. A correct wager, or a "win," results in the payout of a predetermined amount, while an incorrect wager, or a "loss," results in the forfeiture of the cost of the option. This scheme was a variation on a tax avoidance strategy that was heavily marketed and promoted by the financial planning and management industry in the late 1990s. The strategies, which came to be known by names such as BOSS, son-of-BOSS, COBRA, FLIP, BLIP, etc., differed in their particulars; however, each involved creating a high tax basis in a partnership or LLC by executing a series of offsetting transactions. The IRS's subsequent disallowance of these strategies resulted in a number of lawsuits against their developers and promoters.
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No. 09-20734 in com e. As part of their marketing strategy, KPMG promised to provide

in d e p e n d e n t opinions from "several major national law firms" that had analyzed a n d approved the tax strategy. Plaintiffs allege that the law firm of Proskauer R o s e , L.L.P. ("Proskauer") worked with KPMG and other defendants behind the s c e n e s to prepare, in advance, model opinions supporting the validity of the tax sch em e. On the strength of KPMG's assurances, including the promise of

o p in io n s from unnamed law firms, Plaintiffs agreed to participate in the scheme. P la in t iffs later received one of these "independent" opinions from the law firm o f Sidley Austin Brown & Wood, LLP ("Sidley") to the effect that the tax scheme w o u ld likely pass muster with the IRS. After the necessary transactions had been concluded, but before Plaintiffs file d their tax returns, the IRS issued two separate notices addressing certain t y p e s of transactions that the IRS considered to be prohibited. Concerned about t h e import of these notices, Plaintiffs sought tax opinions from Proskauer after t h e issuance of each notice. Proskauer's opinions essentially concluded that P la in t iffs ' transactions were not substantially similar to the prohibited t r a n s a c t io n s , and that the "losses" generated through the tax scheme were t h e r e fo r e likely allowable. Consequently, Plaintiffs need not disclose their

in v o lv e m e n t in the tax scheme on their tax returns. Proskauer further advised t h a t the Sidley and Proskauer opinions should provide Plaintiffs with a s u ffic ie n t defense against IRS penalties in the event that Proskauer's opinion p r o v e d to be incorrect. Following Proskauer's advice, Plaintiffs reported the "losses" from the tax s c h e m e on their 2001 income tax returns, but did not report their involvement in the scheme. The IRS later investigated Plaintiffs for participation in an a b u s i v e tax shelter, and Plaintiffs were required to pay millions of dollars in b a c k taxes, interest, and penalties. Moreover, because they did not report their

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No. 09-20734 in v o lv e m e n t in the tax scheme, they were ineligible for the amnesty extended to t h o s e taxpayers who had disclosed their participation in such schemes. Plaintiffs' original complaint named as defendants all of the entities in v o lv e d in the tax scheme, alleging claims against them under sections 1962 a n d 1964 of the Racketeering Influenced and Corrupt Organizations Act (" R I C O " ), 18 U.S.C. §§ 1962, 1964; sections 10(b) and 20(a) of the Securities E x c h a n g e Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a); Securities and Exchange C o m m is s io n ("SEC") Rule 10b-5, 17 C.F.R. § 240.10b-5; and Texas state law. Plaintiffs settled with all defendants save Proskauer, which moved for dismissal o f the complaint under Federal Rules of Civil Procedure 12(b)(2) and 12(b)(6). The district court concluded that Plaintiffs' ownership interests in the L L C s created under the tax scheme were investment contracts, and thus " s e c u r it ie s " by definition. The court therefore dismissed the RICO claim under t h e Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § § 77z-1, 78u-4, which bars civil RICO actions based on predicate acts of s e c u r it ie s fraud. However, the court gave Plaintiffs leave to replead their

s e c u r it ie s fraud claim against Proskauer with greater particularity. Plaintiffs filed an amended complaint re-alleging their federal securities fr a u d and state law claims. Proskauer moved to dismiss all claims save for the p r o fe s s io n a l malpractice claim. The district court granted the motion,

d is m is s in g the section 10(b) claim for failure to sufficiently plead the elements o f reliance and scienter, and declining to exercise supplemental jurisdiction over t h e related state law claims. This appeal followed. II. DISCUSSION W e review a Rule12(b)(6) dismissal de novo, assuming all well-pleaded, n o n c o n c lu s o r y factual allegations in the complaint to be true. See Ashcroft v. I q b a l, -- U.S. --, 129 S. Ct. 1937, 1949­50 (2009); Lindquist v. City of Pasadena, T e x ., 525 F.3d 383, 386 (5th Cir. 2008). 4

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No. 09-20734 A. The RICO Claim 3 P la in t iffs allege that the defendants named in its original complaint fo r m e d an "enterprise," the common purpose of which was to solicit wealthy t a x p a y e r s to participate in the tax scheme, convince those taxpayers that the s c h e m e was a legitimate tax shelter, and implement the scheme on behalf of t h o s e taxpayers, all in order to collect substantial fees. Plaintiffs further allege t h a t the defendants engaged in a "pattern of racketeering activity" by c o m m it t in g numerous acts of wire and mail fraud in furtherance of their e n te rp ris e . R I C O provides a private right of action for persons harmed by a pattern o f racketeering activity. 18 U.S.C. §§ 1962, 1964(c). However, Congress limited t h is right by amending RICO in 1995, as part of the PSLRA, to bar civil RICO c l a i m s based on "any conduct that would have been actionable as fraud in the p u r c h a s e or sale of securities." 18 U.S.C. § 1964(c). Plaintiffs argue that the d is t r ic t court incorrectly applied this PSLRA bar to their civil RICO claim b e c a u s e neither their ownership interests in the LLCs, nor the digital option c o n t r a c ts themselves, constituted "securities" as defined by the Securities Act of 1 9 3 3 and the Securities Exchange Act of 1934. Because we find that Plaintiffs' o w n e r s h ip interests in the LLCs constituted "investments contracts," and t h e r e fo r e were "securities" within the meaning of the federal securities laws, we a ffir m the district court without reaching the question of whether the digital o p t io n s that Plaintiffs bought and sold also were securities. B o t h the 1933 and 1934 Acts broadly define the term "security" to include, a m o n g other things, an "investment contract." See 15 U.S.C. § 77b(a)(1); 15 U .S .C . § 78c(a)(10). In SEC v. W. J. Howey, Co., the Supreme Court defined an

We review the dismissal of the RICO claim based on the facts alleged in the original complaint, and the dismissal of the securities fraud claims based on the facts alleged in the amended complaint.

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No. 09-20734 in v e s t m e n t contract as "a contract, transaction or scheme whereby a person in v e s t s his money in a common enterprise and is led to expect profits solely from t h e efforts of the promoter or a third party . . . ." 328 U.S. 293, 298­99 (1946). The Howey test thus contains three elements: (1) an investment of money; (2) in a scheme functioning as a common enterprise; (3) with the expectation that p r o fit s will be derived solely from the efforts of individuals other than the in v e s t o r s . SEC v. Koscot Interplanetary, Inc., 497 F.2d 473, 477 (5th Cir. 1974) (c it a t io n s omitted); accord Williamson v. Tucker, 645 F.2d 404, 417­18 (5th Cir. 1 9 8 1 ) (citing Koscot, 497 F.2d 473). With respect to Plaintiffs' interests in the L L C s , the only issue raised on appeal is whether the profits--here, the tax b e n e fits -- w e r e to come solely from the efforts of those other than Plaintiffs.4 W e are not without guidance in deciding this question. In SEC v. Koscot I n te r p la n e ta r y , Inc., we examined a pyramid promotion scheme involving the s a le of cosmetics. Notwithstanding the efforts of the individual investors, who a c t u a lly sold the products and recruited new investors, we found the scheme to b e an investment contract because the promoters of the scheme retained im m e d ia t e control over the essential managerial conduct of the enterprise, and b e c a u s e the investors' realization of profits was inextricably tied to the success o f the promotional scheme. 497 F.2d at 485. In so doing, we held that the proper s t a n d a r d for analyzing the third prong of the Howey test is "whether the efforts m a d e by those other than the investor are the undeniably significant ones, those e s s e n t ia l managerial efforts which affect the failure or success of the enterprise." Id. at 483 (quoting and adopting the standard explicated by the Ninth Circuit in S E C v. Glenn W. Turner Enters., Inc., 474 F.2d 476, 482 (9th Cir. 1973)) (in t e r n a l quotation marks omitted).

Tax benefits may constitute an expectation of "profits" under the Howey test. See Long v. Shultz Cattle Co., 881 F.2d 129, 132­33 n.2 (5th Cir.1989) (citations omitted).

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No. 09-20734 O u r decision not to literally construe the "solely from the efforts of others" t e s t is consistent with the Supreme Court's emphasis on the principle that "economic reality is to govern over form." See Williamson, 645 F.2d at 418 (c it a t io n s omitted). Since Koscot, we have examined a variety of situations in w h i c h investors retained substantial theoretical control, but in fact remained p a s s iv e . In Williamson, we held that an investor's theoretical power to make m a n a g e r ia l decisions did not automatically preclude a finding that the investor r e lie d solely on the efforts of others. Rather, in accordance with the principle t h a t substance is to govern over form, we held that even where an investor fo r m a lly possesses substantial powers, the third prong of the Howey test may be m e t if the investor demonstrates that he is "so inexperienced and u n k n o w le d g e a b le " in the underlying nature of the investment that he is " in c a p a b le of intelligently exercising" his formal rights. Id. at 424. W e applied this standard in Long v. Shultz Cattle Co., 881 F.2d 129 (5th C ir . 1989), where we examined a cattle-feeding consulting agreement designed t o achieve advantageous tax write-offs for investors. Although the investors had t h e formal authority to make such management decisions as the purchase of c a t t le , the choice of a feed yard, and when and to whom to sell, they were not c a t t le m e n and did not have the wherewithal to manage a cattle-feeding business. They therefore relied solely upon the advice and managerial efforts of a third p a r ty in "authorizing" all such decisions. See id. at 134­35. Given the economic r e a lit y of the situation, we held that the expected profits came solely from the e ffo r t s of others. P la in t iffs ' ownership interests in the LLCs are similar to the consulting a g r e e m e n ts held to be investment contracts in Long. The original complaint

d e s c r ib e s the formation, funding, and trading activities of four LLCs: three s in g le -m e m b e r LLCs, capitalized by three separate named Plaintiffs, and a fo u r t h LLC that was capitalized in part by a fourth Plaintiff, an investment 7

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No. 09-20734 e n t i t y , which in turn was largely owned by other named Plaintiffs. Plaintiffs a r g u e that, based on these facts, they retained control over the LLCs. However, Plaintiffs' control was theoretical rather than actual. Plaintiffs d o not plead that they exercised any managerial authority over the LLCs; rather, t h e original complaint states that, under the terms of the investment contracts, t h e LLCs were to be "under the direction of," and "managed by," various in v e s t m e n t consulting and brokerage entities for the purpose of implementing t h e tax scheme. As expressly pled in the original complaint, Plaintiffs were u n a w a r e that the underlying digital options transactions had little or no true e c o n o m ic substance. Plaintiffs thus portrayed themselves as passive investors who depended--both in reality and according to their investment

c o n t r a c ts -- u p o n the efforts of others for their profits. The district court did not e r r in assuming these facts to be true, as it must under Rule 12(b)(6), and d is m is s in g the RICO claim as barred by the PSLRA on the face of the pleadings. B. The Securities Fraud Claim 5 I n the alternative to their RICO claim, Plaintiffs allege violations of s e c t io n s 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § § 78j(b), 78t(a).6 S e c t io n 10(b) makes it unlawful

Plaintiffs argue that it was inherently contradictory for the district court to bar their RICO claim on the ground that the predicate acts were actionable as securities fraud, and then dismiss their securities claims for failure to state a cause of action. However, there is nothing inconsistent about the district court's decisions. Simply because a fraudulent scheme is found to involve the purchase or sale of securities, and therefore "actionable as securities fraud," does not mean that Plaintiffs are exempted from the pleading requirements for securities fraud claims. Plaintiffs have failed to brief and develop their assertion that Proskauer is liable as a "controlling person" under § 20(a) for the fraudulent acts of the other defendants, and have therefore waived that argument. See, e.g., Procter & Gamble Co. v. Amway Corp., 376 F.3d 496, 499 n.1 (5th Cir. 2004) ("Failure adequately to brief an issue on appeal constitutes waiver of that argument." (citations omitted)).
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No. 09-20734 fo r any person, directly or indirectly . . . [t]o use or employ, in c o n n e c t io n with the purchase or sale of any security . . . any m a n ip u la t iv e or deceptive device or contrivance in contravention of s u c h rules and regulations as the [Securities and Exchange] C o m m is s io n may prescribe as necessary or appropriate in the public in t e r e s t or for the protection of investors. 1 5 U.S.C. § 78j(b). Pursuant to this section, the SEC promulgated Rule 10b-5, which makes it unlawful fo r any person, directly or indirectly . . . (a ) To employ any device, scheme, or artifice to defraud, (b ) To make any untrue statement of a material fact or to omit t o state a material fact necessary in order to make the s t a t e m e n t s made, in the light of the circumstances under w h ic h they were made, not misleading, or (c ) To engage in any act, practice, or course of business which o p e r a t e s or would operate as a fraud or deceit upon any p erson , in connection with the purchase or sale of any security. 1 7 CFR § 240.10b-5. T h e Supreme Court has found an implied private cause of action in section 1 0 (b ) and its implementing regulation. Stoneridge Inv. Partners, LLC v.

S c ie n tific -A tla n ta , Inc., 552 U.S. 148, 157 (2008) (citing Superintendent of Ins. o f N.Y. v. Bankers Life & Cas. Co., 404 U.S. 6, 13 n.9 (1971)). To state a private c la im under section 10(b), a plaintiff must prove: (1 ) a material misrepresentation or omission by the defendant; (2) s c ie n t e r ; (3) a connection between the misrepresentation or omission a n d the purchase or sale of a security; (4) reliance upon the m is r e p r e s e n t a t io n or omission; (5) economic loss; and (6) loss c a u s a tio n . I d . (citing Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341­42 (2005)).

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No. 09-20734 T h e district court held that Plaintiffs failed to sufficiently plead the e le m e n t s of reliance and scienter. We agree that Plaintiffs failed to show

r e lia n c e on Proskauer. Without direct attribution to Proskauer of its role in the t a x scheme, reliance on Proskauer's participation in the scheme is too indirect fo r liability. We therefore do not reach the issue of scienter. W e begin our discussion of relevant case law with the Supreme Court's d e c is io n in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 5 1 1 U.S. 164 (1994). Central Bank involved the issuance of bonds by a public b u ild in g authority. Central Bank of Denver, the indenture trustee for the bond is s u e s , had reason to suspect that the appraisal of the real estate securing the b o n d s may have been inflated. The plaintiffs alleged that the bank aided and a b e t te d the issuer in committing securities fraud by agreeing to delay an in d e p e n d e n t appraisal of the real estate until after the closing on the bond issue. Id. at 167­68. After reviewing the text and history of section 10(b), the Court concluded t h a t a private plaintiff may not maintain an aiding and abetting suit under s e c t io n 10(b). To hold otherwise, explained the Court, would "impose . . . liability w h e n at least one element critical for recovery under 10b-5 is absent: reliance." Id. at 180 (citing Basic Inc. v. Levinson, 485 U.S. 244, 243 (1988)). Nevertheless, t h e Court acknowledged that private plaintiffs could still hold "secondary actors" lia b le for fraudulent conduct under certain circumstances: A n y person or entity, including a lawyer, accountant, or bank, who e m p lo y s a manipulative device or makes a material misstatement (o r omission) on which a purchaser or seller of securities relies may b e liable as a primary violator under 10b-5, assuming all of the r e q u ir e m e n t s for primary liability under Rule 10b-5 are met. Id. at 191 (citation omitted). T h e Supreme Court has not directly addressed the question we answer in t h is case--whether a secondary actor can be held liable in a private section 10(b)

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No. 09-20734 a c t io n for deceptive conduct not attributed to it before an investor decides to in v e s t . However, the Court's recent decision in Stoneridge Investment Partners, L L C v. Scientific-Atlanta, Inc. is instructive. In Stoneridge, investors alleging losses after purchasing common stock s o u g h t to impose liability on entities that had agreed to sham purchase and sale c o n t r a c ts with the issuing corporation. These transactions fooled the

c o r p o r a t io n 's auditor, thus allowing the corporation to publish a misleading f i n a n c ia l statement affecting the share price. The Court granted certiorari to r e s o lv e a conflict between the courts of appeals as to "when, if ever, an injured i n v e s to r may rely upon § 10(b) to recover from a party that neither makes a p u b lic misstatement nor violates a duty to disclose but does participate in a s c h e m e to violate § 10(b)." 552 U.S. at 156 (citing Simpson v. AOL Time Warner I n c ., 452 F.3d 1040 (9th Cir. 2006); Regents of Univ. of Cal. v. Credit Suisse First B o s to n (USA), Inc., 482 F.3d 372 (5th Cir. 2007)). Invoking a theory that some courts have called "scheme liability," the p la in t iff in Stoneridge contended that liability was appropriate even absent a p u b lic statement or duty to disclose because the third-party entities "engaged in c o n d u c t with the purpose and effect of creating a false appearance of material fa c t to further a [fraudulent] scheme." Id. at 159-60. The Court rejected that t h e o r y , stating that the plaintiff's view of primary liability makes any aider and abettor liable under § 10(b) if he or she c o m m it t e d a deceptive act in the process of providing assistance. Were we to adopt this construction of § 10(b), it would revive in s u b s t a n c e the implied cause of action against all aiders and abettors e x c e p t those who committed no deceptive act in the process of fa c ilit a t in g the fraud; and we would undermine Congress' d e t e r m in a t io n that this class of defendant should be pursued by the S E C and not by private litigants. I d . at 162­63 (citations omitted). The Court premised its holding upon its view t h a t the "scheme liability" theory failed to answer the objection that the plaintiff 11

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No. 09-20734 " d id not in fact rely upon respondents' own deceptive conduct." Id. at 160 (e m p h a s e s added). Because "[n]o member of the investing public had knowledge, e it h e r actual or presumed, of respondents' deceptive acts during the relevant t im e s ," the Court held that the plaintiff "cannot show reliance upon any of r e s p o n d e n t s ' actions except in an indirect chain that we find too remote for lia b ilit y ." Id. at 159. P la in t iffs effectively adopt this "scheme liability" theory in urging us to h o ld that a defendant can be liable for participating in the creation of a false s t a t e m e n t or misrepresentation that investors rely upon, regardless of whether t h a t statement is attributed to that defendant at the time of dissemination. The c a u s a l chain between Proskauer's conduct and Plaintiffs' injury is admittedly s h o r t e r than in Stoneridge. However, Plaintiffs bear a heavy burden in showing t h a t they in fact relied upon Proskauer's own deceptive conduct. The Supreme C o u r t 's focus on reliance in Stoneridge favors a rule that preserves the r o b u s t n e s s of that element in private securities actions. See id. ("Reliance by the p la in t iff upon the defendant's deceptive acts is an essential element of the § 10(b) private cause of action. It ensures that, for liability to arise, the

`r e q u is it e causal connection between a defendant's misrepresentation and a p la in t iff's injury' exists as a predicate for liability.") (quoting Basic, 485 U.S. at 2 4 3 ). Furthermore, Stoneridge appears to imply that a secondary actor's conduct o r statement must be known to the investor in order for the investor to rely upon it . See id. W e therefore conclude that explicit attribution is required to show reliance u n d e r section 10(b). We find persuasive the reasoning of the Second Circuit in P a c ific Investment Management Co. v. Mayer Brown LLP, 603 F.3d 144 (2d Cir. 2 0 1 0 ). In Pacific Investment, the court addressed two questions about the scope o f federal securities laws: (1) whether, under section 10(b) and Rule 10b-5, a c o r p o r a t io n 's outside counsel could be liable for false statements that those 12

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No. 09-20734 a t t o r n e y s allegedly created, but which were not attributed to the law firm or its a t t o r n e y s at the time the statements were made; and (2) whether plaintiffs' c la im that outside counsel participated in a scheme to defraud investors was p r e c lu d e d by the Supreme Court's decision in Stoneridge. Id. at 148. The court h e ld that a "secondary actor"--such as a lawyer, accountant, or bank not e m p l o y e d by the firm whose securities are at issue--can be held liable in a p r iv a t e section 10(b) action only for false statements attributed to that secondary actor at the time of dissemination. Id. & n.1. "Absent attribution, p la in t iffs cannot show that they relied on defendants' own false statements, and p a r tic ip a t io n in the creation of those statements amounts, at most, to aiding and a b e t tin g securities fraud." Id. at 148. K n o w in g the identity of the speaker is essential to show reliance because a word of assurance is only as good as its giver. Clients engage "name-brand" la w firms at premium prices because of the security that comes from the general r e p u t a tio n s of such firms for giving sound advice, or for winning trials. Specific a t t r ib u t io n to a reputable source also induces reliance because of the ability to h o ld such a party responsible should things go awry. As Plaintiffs themselves a lle g e in their amended complaint: T o convince skeptical taxpayers that the strategies were legitimate, t h e investment consultants needed to offer more than their own selfin t e r e s t e d assurances. They needed lawyers to provide `in d e p e n d e n t ' legal opinions supporting the tax strategies. And not ju s t any lawyers would do. The complexity of the strategies and the t e c h n ic a l nature of income-tax rules made it imperative that p r o m o t e r s provide taxpayers with formal tax opinions from r e p u t a b le national law firms. Taxpayers wanted solid assurance t h a t the deals had been reviewed and approved by attorneys from p r o m in e n t national law firms with reputations as authorities on tax la w . K P M G 's advertisement of support from "major national law firms" makes t h is a closer case than if KPMG had not so characterized the sources of the tax

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No. 09-20734 o p in io n s . However, KPMG's representation still falls short of showing that P la in t iffs relied on Proskauer itself. Borrowing from the language of the Second C ir c u it: A t tr ib u t io n is necessary to show reliance. Where statements are p u b lic ly attributed to a well-known national law or accounting firm, b u y e r s and sellers of securities (and the market generally) are more lik e ly to credit the accuracy of those statements. Because of the fir m 's imprimatur, individuals may be comforted by the supposedly im p a r t ia l assessment and, accordingly, be induced to purchase a p a r t ic u la r security. Without explicit attribution to the firm, h o w e v e r , reliance on that firm's participation can only be shown t h r o u g h `an indirect chain . . . too remote for liability.' I d . at 156 (quoting Stoneridge, 552 U.S. at 159). Applying this standard here, we conclude that the district court properly d is m is s e d Plaintiffs' securities fraud claims against Proskauer. The amended c o m p la in t alleges that "law firms (such as Proskauer Rose and Sidley Austin B r o w n & Wood) . . . [worked with other defendants] to promote, sell, and support t h e tax strategies on a broad scale"; that the promoters' "associations with P r o s k a u e r , Sidley, and others allowed [them] to offer skeptical taxpayers the a s s u r a n c e that the strategies had been reviewed and approved in `independent' t a x opinions from several major national law firms"; that a partner at Proskauer w o r k e d with other defendants to refine the tax strategies, review the marketing m a t e r ia ls , and create model template opinions addressing the tax consequences a n d reporting requirements of the tax transactions; that the strategy c o n t e m p la t e d that the taxpayer would receive one or more of these opinions from h is choice of four firms, including Proskauer; that Plaintiffs were assured that " s e v e r a l major national law firms had also vetted the [tax scheme] and could p r o v i d e Plaintiffs [with] an `independent' opinion corroborating KPMG's r e p r e s e n t a t io n s " ; and that, based in part on "the assurance that national law

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Case: 09-20734 Document: 00511276237 Page: 15 Date Filed: 10/27/2010

No. 09-20734 fir m s such as Proskauer and Sidley were prepared to provide opinions s u p p o r t in g the [tax scheme], Plaintiffs agreed to the deal." W h ile these allegations paint a clear picture of Proskauer's intimate in v o lv e m e n t in the tax scheme, Plaintiffs scrupulously avoid any explicit a s s e r tio n that they had knowledge of Proskauer's role prior to their actual in v e s t m e n t in the tax scheme. They do not allege that they ever saw or heard a n y Proskauer work product before making their decision, nor do they explicitly a lle g e that the promoters specifically identified Proskauer as one of the "major n a t io n a l law firms" that had vetted and cleared the tax scheme or that had a g r e e d to provide opinions supporting the same. In short, Plaintiffs do not allege t h a t they knew of Proskauer's role in the tax scheme during the relevant time p e r io d when they were making their investment decisions.7 In the absence of a n y such attribution to Proskauer, we find that Plaintiffs have failed to show r e lia n c e on Proskauer. As the Supreme Court has explained, securities law is "an area that d e m a n d s certainty and predictability." Central Bank, 511 U.S. at 188 (quoting P in te r v. Dahl, 486 U.S. 622, 652 (1988)) (internal quotation marks omitted). The attribution requirement that we adopt today makes clear the boundary b e t w e e n primary violators--who are open to liability in private securities a c t io n s -- a n d aiders and abettors, to whom the private right of action under s e c t io n 10(b) does not extend.8

Proskauer's explicit involvement in the scheme--the two tax opinions regarding the IRS reporting requirements--were rendered well after the purchase of the digital options and the creation of Plaintiffs' interests in the LLCs. They therefore cannot form the basis for liability under Rule 10b-5, as Plaintiffs cannot demonstrate "a connection between the misrepresentation or omission and the purchase or sale of a security." Stoneridge, 552 U.S. at 157. The Fourth Circuit has also considered the attribution question post-Stoneridge. In In re Mutual Funds Investment Litigation, 566 F.3d 111 (4th Cir. 2009), cert. granted, Janus Capital Group, Inc. v. First Derivative Traders, 130 S. Ct. 3499 (2010), the court held that
8

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Case: 09-20734 Document: 00511276237 Page: 16 Date Filed: 10/27/2010

No. 09-20734 I I I . CONCLUSION F o r the reasons stated above, the judgment of the district court is A F F IR M E D .

a plaintiff seeking to rely on the fraud-on-the-market presumption must ultimately prove that interested investors (and therefore the market at large) would attribute the allegedly misleading statement to the defendant. At the complaint stage a plaintiff can plead fraud-on-the-market reliance by alleging facts from which a court could plausibly infer that interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributed to the defendant. Id. at 124 (citations omitted) (emphases added). The court explicitly cabined its holding to the "limited context of fraud-on-the-market," declining to "establish an attribution standard for all reliance inquiries." Id. at 123. Our case is not a fraud-on-the-market case. Although we have some concern about whether the Fourth Circuit's standard comports with the Supreme Court's stated goals of "certainty and predictability" in securities law and, accordingly, whether we would adopt that standard for the fraud-on-the-market context, we need not decide that today.

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