Lampkin, et al v. UBS Painewebber Inc, et al
OPINION AND ORDER (Signed by Judge Melinda Harmon) Parties notified.(rhawkins)
United States District Court
Southern District of Texas
February 28, 2017
IN THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF TEXAS
In Re ENRON CORPORATION
SECURITIES, DERIVATIVE &
KEVIN LAMPKIN, JANICE SCHUETTE,§
ROBERT FERRELL, AND STEPHEN
MILLER, Individually and on
Behalf of All Others Similarly §
UBS PAINEWEBBER, INC. AND
UBS WARBURG, LLC,
David J. Bradley, Clerk
CIVIL ACTION NO. H-02-0851
OPINION AND ORDER
violations of the following securities fraud statutes through
Defendants’ scheme to optimize revenue in investment banking fees
from UBS Securities LLC’s corporate client, Enron Corp. (“Enron”),
at the expense and defrauding of UBS Financial Service’s brokerage
retail clients, Lead Plaintiffs Kevin Lampkin, Janice Schuette,
Bobby Ferrell, Stephen Miller, Terry Nelson, Diane Swiber, Franklin
Gittess, and Joe Brown and similarly situated individuals: §§ 11,
12(a)(2) and 15 of the Securities Act of 1933 (“the 1933 Act”), 15
U.S.C. §§ 77k, 77l, and 77o, et seq.; §§
10(b) and 20 of the
Securities Exchange Act of 1934 (“the 1934 Act”), 15 U.S.C. §§
78j(b) and 78(t), et seq., and Rule 10b-5, 17 C.F.R. § 240.10b-5;
and the Private Securities Litigation Reform Act (“PSLRA”), 15
The 1933 Act claims are brought against UBS
Financial Services, Inc. f/k/a UBS Paine Webber, Inc. (“PW”) only.
#122 ¶¶ 228, 269.
Pending before the Court are (1) a motion to dismiss the
Third Amended Complaint,1 filed by Defendants PW2 and UBS Securities
Memorandum in support, #126); (2) an alternative motion for leave
to amend complaint from Lead Plaintiffs Kevin Lampkin, Janice
Schuette, Bobby Ferrell, Stephen Miller, Terry Nelson, Diane Swiber,
Franklin Gittess, and Joe Brown; (#164);(3) a motion to certify
class (#166), filed by Lead Plaintiffs; and (4) an opposed motion
for amended scheduling order, for additional briefing, and for a
ruling (#223), filed by Plaintiffs.
independently of the complaints in the Newby and Tittle actions in
Third Amended Complaint is instrument #122.
PW is a Delaware corporation authorized to do business
in Texas and is a wholly owned subsidiary of Switzerland’s banking
conglomerate UBS AG. #122 at ¶ 13.
Warburg is a Delaware limited liability company
authorized to do business in Texas and also a wholly owned
subsidiary of UBS AG. #122 ¶ 14.
Warburg and PW are collectively referred to as
“Defendants.” #122 ¶ 15. Warburg, PW and UBS AG are collectively
referred to as “UBS.” Id.
As housekeeping matters, given the age of this litigation,
the lengthy discovery period now closed, and the extensive briefing
already filed in this case regarding the claims against the UBS
Defendants, the Court denies the motion for amended scheduling order
and for additional briefing as unnecessary (#223).
complaints (#1, 6, 20, and 122), the Court denies their alternative
motion for leave to file another (#164).
Finally, in light of the
issuance of this Opinion and Order, the Court finds that the
remaining motion for a ruling (also part of #223) is MOOT.
accusations, and denigrating remarks in the various documents it
reviews and focuses on the merits of the parties’ contentions.
Standards of Review
Federal Rule of Civil Procedure 8(a) states,
A pleading that states a claim for relief must
(1) a short and plain statement of the grounds
for the court’s jurisdiction, unless the court
already has jurisdiction, and the claim needs
no new jurisdictional support;
(2) a short and plain statement of the claim
showing that the pleader is entitled to relief;
(3) a demand for the relief sought, which may
include relief in the alternative or different
types of relief.
Under the Rule’s requirement of notice pleading, “defendants in all
lawsuits must be given notice of specific claims against them.”
Anderson v. U.S. Dept. of Housing and Urban Development, 554 F.3d
525, 528 (5th Cir. 2008).
While a plaintiff need not plead specific
facts, the complaint must provide “the defendant fair notice of what
the . . . claim is and the grounds upon which it rests.”
Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007).
complaint lacks facts necessary to put a defendant on notice of what
conduct supports the plaintiff’s claims against it, the complaint
is inadequate to meet the notice pleading standard.
The complaint must not only name the laws which the
defendant has allegedly violated, but also allege facts about the
conduct that violated those laws.
When a district court reviews a motion to dismiss pursuant
to Fed. R. Civ. P. 12(b)(6), it must construe the complaint in favor
of the plaintiff and take all well-pleaded facts as true. Randall
D. Wolcott, MD, PA v. Sebelius, 635 F.3d 757, 763 (5th Cir. 2011),
citing Gonzalez v. Kay, 577 F.3d 600, 603 (5th Cir. 2009).
Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009)(“The tenet
that a court must accept as true all of the allegations contained
in a complaint is inapplicable to legal conclusions.”), citing Bell
Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007); Hinojosa v.
U.S. Bureau of Prisons, 506 Fed. Appx. 280, 283 (5th Cir. Jan. 7,
“While a complaint attacked by a Rule 12(b)(6) motion to
dismiss does not need detailed factual allegations, . . . a
‘entitle[ment] to relief’ requires more than labels and conclusions,
and a formulaic recitation of the elements of a cause of action will
not do . . . .”
Twombly, 550 U.S. at 555 (citations omitted).
“Factual allegations must be enough to raise a right to relief above
the speculative level.”
Id. at 1965, citing 5 C. Wright & A.
Miller, Federal Practice and Procedure § 1216, pp. 235-236 (3d ed.
2004)(“[T]he pleading must contain something more . . . than . . .
a statement of facts that merely creates a suspicion [of] a legally
cognizable right of action”). “Twombly jettisoned the minimum notice
pleading requirement of Conley v. Gibson, 355 U.S. 41 . . .
(1957)[“a complaint should not be dismissed for failure to state a
claim unless it appears beyond doubt that the plaintiff can prove
no set of facts in support of his claim which would entitle him to
relief”], and instead required that a complaint allege enough facts
to state a claim that is plausible on its face.”
St. Germain v.
Howard,556 F.3d 261, 263 n.2 (5th Cir. 2009), citing In re Katrina
Canal Breaches Litig., 495 F.3d 191, 205 (5th Cir. 2007)(“To survive
a Rule 12(b)(6) motion to dismiss, the plaintiff must plead ‘enough
facts to state a claim to relief that is plausible on its face.’”),
citing Twombly, 127 S. Ct. at 1974 [550 U.S. at 570]).
has facial plausibility when the pleaded factual content allows the
court to draw the reasonable inference that the defendant is liable
for the misconduct alleged.’”
Montoya v. FedEx Ground Package
System, Inc., 614 F.3d 145, 148 (5th Cir. 2010), quoting Ashcroft v.
Iqbal, 556 U.S. 662, 678 (2009).
The plausibility standard is not
akin to a “probability requirement,” but asks for more than a
“possibility that a defendant has acted unlawfully.”
U.S. at 556.
“[T]hreadbare recitals of the elements of a cause of
action, supported by mere conclusory statements do not suffice”
under Rule 12(b).
Iqbal, 556 U.S. at 678.
Dismissal under Rule 12(b)(6) is proper not only where the
plaintiff fails to plead sufficient facts to support a cognizable
legal theory, but also where the plaintiff fails to allege a
cognizable legal theory.
Kjellvander v. Citicorp, 156 F.R.D. 138,
140 (S.D. Tex. 1994), citing Garrett v. Commonwealth Mortgage Corp.,
938 F.2d 591, 594 (5th Cir. 1991); ASARCO LLC v. Americas Min.
Corp., 832 B.R. 49, 57 (S.D. Tex. 2007).
“A complaint lacks an
‘arguable basis in law’ if it is based on an indisputedly meritless
legal theory’ or a violation of a legal interest that does not
Ross v. State of Texas, Civ. A. No. H-10-2008, 2011 WL
5978029, at *8 (S.D. Tex. Nov. 29, 2011).
As noted, on a Rule 12(b)(6) review, although generally
the court may not look beyond the pleadings, the court may examine
the complaint, documents attached to the complaint, and documents
attached to the motion to dismiss to which the complaint refers and
which are central to the plaintiff’s claim(s), as well as matters
of public record.
Lone Star Fund V (U.S.), L.P. v. Barclays Bank
PLC, 594 F.3d 383, 387 (5th Cir. 2010), citing Collins, 224 F.3d at
498-99; Cinel v. Connick, 15 F.3d 1338, 1341, 1343 n.6 (5th Cir.
1994). See also United States ex rel. Willard v. Humana Health Plan
of Tex., Inc., 336 F.3d 375, 379 (5th Cir. 2003)(“the court may
consider . . . matters of which judicial notice may be taken”).
Taking judicial notice of public records directly relevant to the
issue in dispute is proper on a Rule 12(b)(6) review and does not
transform the motion into one for summary judgment. Funk v. Stryker
Corp., 631 F.3d 777, 780 (5th Cir. 2011).
“A judicially noticed
fact must be one not subject to reasonable dispute in that it is
either (1) generally known within the territorial jurisdiction of
the trial court or (2) capable of accurate and ready determination
Fed. R. Evid. 201(b).
Plaintiffs object to Defendants’ attachment of significant
amounts of extrinsic evidence to their motion and then arguing fact
issues utilizing extrinsic evidence as support, both of which are
inappropriate in a motion to dismiss.4
The Court finds this
objection to be unfounded.
“‘[D]ocuments that a defendant attaches to its motion to
dismiss are considered part of the pleadings if they are referred
to in the plaintiff’s complaint and are central to [its] claim.’”
Collins v. Morgan Stanley Dean Witter, 224 F.3d 496, 498-99 (5th
Cir. 2000), quoting Venture Assocs. Corp. v. Zenith Data Sys. Corp.,
987 F.2d 429, 431 (7th Cir. 1993).
“[W]hen a plaintiff does not
attach a pertinent document to the complaint, a ‘defendant may
Shepard v. Texas Dept. of Transportation, 158 F.R.D.
592, 595 (E.D. Tex. 1994); Charles Alan Wright, et al., 5A Federal
Practice and Procedure:
Civil § 1327 (3d ed. April 2016 update).
All the documents that Defendants attach to their motion to dismiss
were referenced and relied upon by Plaintiffs in their Third Amended
Complaint, and are central to their claims.
Plaintiffs have not
questioned the authenticity of the documents.
By such attachments
the defendant simply provides additional notice of the basis of the
suit to the plaintiff and aids the Court in determining whether a
claim has been stated.
Id. at 499.
The attachments may also
provide the context from which any quotation or reference in the
The Court does not address Plaintiffs’ arguments about
the pleading standard for scheme liability under Rule 10b-5(a) and
(c) because of the Supreme Court’s later rejection of such claims
motion is drawn to aid the court in correctly construing that
quotation or reference.
In re Enron Corp. Securities, Derivative
& “ERISA” Litig., No. H-04-0087, 2005 WL 3504860, at 11 n.20 (S.D.
Tex. Dec. 22, 2005).
“Where the allegations in the complaint are
contradicted by facts established by documents attached as exhibits
to the complaint, the court may properly disregard the allegations.”
Martinez v. Reno, No. 3:97-CV-0813-P, 1997 WL 786250, at *2 (N.D.
Tex. Dec. 15, 1997), citing Nishimatsu Const. Co. v. Houston Nat’l
allegations and unwarranted deductions of fact are contradicted by
facts disclosed in the appended exhibit, which is treated as part
of the complaint, the allegations are not admitted as true.
v. Target Corp., 541 Fed. Appx. 413, 417 (5th Cir. Oct. 4, 2013),
citing Associated Builders, Inc. v. Alabama Power Co., 505 F.2d 97,
100 (5th Cir. 1974), citing Ward v. Hudnell, 366 F.2d 247 (5th Cir.
See Northern Indiana Gun & Outdoor Shows, Inc. v. City of
South Bend, 163 F.3d 449, (7th Cir. 1996)(“It is a well settled rule
that when a written instrument contradicts allegations in the
allegations.”); Roth v. Jennings, 489 F.3d 499, 509 (2d Cir.
2007)(when attached documents contain statements that contradict the
allegations in the complaint, the documents control and the court
“Rule 9(b) supplements but does not supplant Rule 8(a)’s
notice pleading,” and “requires “only ‘simple, concise, and direct’
allegations of the ‘circumstances constituting fraud,’ which after
Twombly must make relief plausible, not merely conceivable, when
taken as true.”
U.S. ex rel. Grubbs v. Kanneganti, 565 F.3d 180,
186 (5th Cir. 2009).
Rule 9(b) provides,
In all averments of fraud or mistake, the
circumstances constituting fraud or mistake
shall be stated with particularity.
intent, knowledge, and other condition of mind
of a person must be averred generally.
“In every case based upon fraud, Rule 9(b) requires the
plaintiff to allege as to each individual defendant ‘the nature of
the fraud, some details, a brief sketch of how the fraudulent scheme
operated, when and where it occurred, and the participants.”
Hernandez v. Ciba-Geigy Corp. USA, 200 F.R.D. 285, 291 (S.D. Tex.
In a securities fraud suit, the plaintiff must plead with
particularity the circumstances constituting the alleged fraud:
contended to be fraudulent, identify the speaker, state when and
where the statements were made, and explain why the statements were
fraudulent.’” Southland Securities Corp. v. INspire Ins. Solutions,
Inc., 365 F.3d 353, 362 (5th Cir. 2004), quoting Williams v. WMX
Technologies, Inc., 112 F.3d 175, 177-78 (5th Cir. 1997), cert.
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denied, 522 U.S. 966 (1997).
“‘In cases concerning fraudulent
requires the claimant to plead the type of facts omitted, the place
in which the omissions should have appeared, and the way in which
the omitted facts made the representations misleading.’”
v. Fort James Corp., 470 F.3d 1171, 1174 (5th Cir. 2006), quoting
United States ex rel. Riley v. St. Luke’s Hosp., 355 F.3d 370, 381
(5th Cir. 2004).
Unlike the alleged fraud, Rule 9(b) allows a plaintiff to
plead intent to deceive or defraud generally.
Nevertheless a mere
conclusory statement that the defendant had the required intent is
insufficient; the plaintiff must set forth specific facts that raise
an inference of fraudulent intent, for example, facts that show the
Tuchman v. DSC Communications Corp., 14 F.3d
generally, case law amply demonstrates that pleading scienter
To plead scienter adequately, a plaintiff must
set forth specific facts that support an inference of fraud.”);
Melder v. Morris, 27 F.3d 1097, 1102 (5th Cir. 1994).
The particularity requirement of Rule 9(b) also governs
a conspiracy to commit fraud. Southwest Louisiana Healthcare System
v. MBIA Ins. Corp., No. 05-1299, 2006 WL 1228903, *5 & n.47 (W.D.
La. May 6, 2006); Hernandez v. Ciba-Geigy Corp. USA, No. Civ. A. B-
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00-82, 2000 WL 33187524, *4 (S.D. Tex. Oct. 17, 2000)(“The weight
of Fifth Circuit precedent holds that a civil conspiracy to commit
a tort that sounds in fraud must be pleaded with particularity.”);
In re Ford Motor Co. Vehicle Paint Litigation, No. MDL 1063, 1994
WL 426548, *34 (E.D. La. July 30, 1996); and Castillo v. First City
Bancorporation of Texas, Inc., 43 F.3d 953, 961 (5th Cir. 1994).
A dismissal for failure to plead with particularity in
accordance with Rule 9(b) is treated as a Rule 12(b)(6) dismissal
for failure to state a claim.
Lovelace v. Software Spectrum, Inc.,
78 F.3d 1015, 1017 (5th Cir. 1996).
The Exchange Act and
the PSLRA’s Heightened Pleading Requirements
Section 10(b) of the Securities Exchange Act of 1934, as
amended, 15 U.S.C. § 78j(b), states in relevant part,
It shall be unlawful for any person, directly
or indirectly, by the use of any means or
instrumentality of interstate commerce or of
any facility of any national securities
exchange . . .
(b) To use or employ in connection with the
purchase or sale of any security registered on
a national securities exchange or any security
not so registered, or any securities-based swap
agreement (as defined in [S]ection 206B of the
Gramm-Leach-Bliley Act), any manipulative or
contravention of such rules and regulations as
the Commission may prescribe as necessary or
appropriate in the public interest or for the
protection of investors.
Pursuant to the statute, the Securities and Exchange
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Commission (“SEC”) promulgated Rule 10b-5, 17 C.F.R. § 240.10b-5,
It shall be unlawful for any person, directly
or indirectly, by the use of any means or
instrumentality of interstate commerce, or of
the mails or of any facility of any national
(a) to employ any device, scheme, or artifice
(b) To make any untrue statement of a material
fact or to omit to state a material fact
necessary in order to make the statements made,
in the light of the circumstances under which
they were made, not misleading, or
(c) To engage in any act, practice, or course
of business which operates or would operate as
a fraud or deceit upon any person, in
connection with the purchase or sale of any
Although the statute does not expressly provide for a private cause
of action, the Supreme Court has recognized that the statute and its
implementing regulation imply a private cause of action for § 10(b)
Stoneridge Inv. Partners, LLC v. Scientific-Atlanta,
552 U.S. 148, 157 (2008), citing Superintendent of Ins. of N.Y. v.
Bankers Life & Casualty Co., 404 U.S. 6, 13 n.9 (1971).
To state a claim under § 10(b) of the 1934 Act and Rule
10b-5, 17 C.F.R. § 240.10b-5, the plaintiff must plead “(1) a
scienter; (3) a connection between the misrepresentation or omission
and the purchase or sale of a security; (4) reliance upon the
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misrepresentation or omission; (5) economic loss; and (6) loss
Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 341-42 (2005).
omission is material for purposes of federal securities law if there
is a “substantial likelihood that the disclosure of omitted fact
significantly altered the ‘total mix’ of information available.”
TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976);
Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988)(“adopt[ing] TSC
Industries standard of materiality for the § 10(b) and Rule 10b-5
Loss causation, i.e., a causal connection between the
fraudulent conduct) and the economic loss to the plaintiff for which
it seeks to recover, can be proven by showing that when the relevant
truth about the fraud is
disclosed to or leaked into the market
place, whether at once or in a series of events, whether by the
defendant’s announcing changes in its accounting treatments, or
resignations of key officers, or newspapers and journals, etc., it
caused the price of the stock to decline and thereby proximately
caused the plaintiff’s economic injury.
Lormand v. US Unwired,
Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342 (2005).
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Fifth Circuit has held that Rule 8(a)(2) and Twombly’s plausibility
standard govern the pleading of loss causation.
Id. at 256-58.
For many years plaintiffs in securities fraud suits
brought claims under § 10(b) and Rule 10b-5 against secondary
actors,5 including investment bankers, lawyers, and accountants, who
In the last twenty years, the Supreme Court has greatly
limited the reach of a private right of action against secondary
actors under Rule 10b-5(a) and (c). Despite the fact that for three
decades secondary actors had been found liable under the federal
securities laws as aiders and abettors in lower courts, given the
1934 Act’s silence as to aiding and abetting, the Supreme Court has
concluded, “The section 10(b) implied private right of action does
not extend to aiders and abettors.”
Stoneridge, 552 U.S. at 158;
see also Central Bank of Denver, N.A. v. First Interstate Bank of
Judge Jose A. Cabranes in Pacific Inv. Management Co.,
LLC v. Mayer Brown LLP, 603 F. 3d 144, 148 n.1 (2d Cir. 2010),
cert. denied, 564 U.S. 1018 (2011), defines “secondary actor” as
a term for “lawyers . . . , accountants, or other parties who are
not employed by the issuing firm whose securities are the subject
of allegations of fraud.”
Id., citing Stoneridge Investment
Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 166
(2008)(”using the term ‘[s]econdary actors’ to refer to an issuing
firm’s customers and suppliers”), and Central Bank of Denver, N.A.
v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 191
(1994)(characterizing “lawyer[s], accountant[s] or bank[s]” as
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Denver, N.A., 511 U.S. 164, 177-78 (1994)(for private parties6
Section 10(b) “does not itself reach those who aid and abet” a
primary wrongdoer’s violation of the securities laws because while
the statute prohibits the making of a material misstatement or
omission or the commission of a manipulative act,7 the “proscription
does not “include giving aid to a person who commits a manipulative
or deceptive act”; “We cannot amend the statute to create liability
for acts that are not themselves manipulative or deceptive within
the meaning of the statute.”
511 U.S. at 177-78.
defendant committed its own primary violation of the securities laws
to be held liable under § 10(b).
Moreover the Supreme Court
concluded that in some circumstances secondary actors, like lawyers,
investment banks, and accountants, “who employ a manipulative
The PSLRA added Section 20(e), 15 U.S.C. § 78t(e), to
the 1934 Act, affirming the right of the SEC to prosecute aiders
and abettors in enforcement actions, but not private plaintiffs.
The word “manipulative” is a term of art when used in
the context of securities markets and connotes intentional or
willful conduct designed to deceive or defraud investors by
controlling or artificially affecting the price of securities.”
Regents of Univ. of Calif. v. Credit Suisse First Boston (USA),
Inc., 482 F.3d 372, (5th Cir. 2007)(citing Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 199 (1976)), cert. denied sub nom.
Regents of Univ. of Calif. v. Merrill Lynch, Pierce, Fenner &
Smith, 552 U.S. 1170 (2008).
The term “‘refers generally to
practices, such as wash sales, matched orders, or rigged prices,
that are intended to mislead investors by artificially affecting
market activity.’” Id., quoting Santa Fe Indus. v. Green, 430 U.S.
462, 476 (1977).
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device or make a material misstatement (or omission) on which a
purchaser or seller of securities relies,” can be liable as primary
violators if “all the requirements for primary liability under Rule
10b-5 are met.” Id. at 191. In accord, Stoneridge, 552 U.S. at 158
(For a secondary actor to be held liable under § 10(b), that person
or entity “must satisfy each of the elements or preconditions for
“Where liability is premised on a failure to disclose
rather than on a misrepresentation, ‘positive proof of reliance9 is
Plaintiffs argue that this Court is bound by its earlier
determination in In re Enron Corp. Securities, Derivative & “ERISA”
Litig., 439 F. Supp. 2d 692, 722 (S.D. Tex. 2006) that the
applicable level of particularity required is different for
omission and scheme cases is that set forth in In re Parmalat Sec.
Litig., 376 F. Supp. 2d 472, 492 (S.D.N.Y. 2005)(“The pleading
requirements of the PSLRA regarding misleading statements and
omissions do not apply to claims that allege no misrepresentation
or omission, but instead are based on employing any device, scheme
or artifice to defraud or engaging in any act, practice or course
of business that operates or would operate as a fraud or deceit
upon any person in connection with the purchase or sale of any
security; however those claims sound in fraud and therefore come
within” Rule 9(b)).
Not only does this Court have the ability to reconsider
its prior rulings, but it observes that some key decisions about
pleading requirements have been issued since by the Supreme Court,
including Stoneridge (rejecting scheme liability), Janus Capital
(2011)(clarifying who “makes a statement”), and Halliburton Co. V.
Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014)(same), all of
which are discussed infra. The Court does not address Plaintiffs’
scheme liability aiding and abetting claims, which are no longer
viable in the wake of Central Bank and Stoneridge.
“[P]roof of reliance ensures that there is a proper
‘connection between a defendant’s misrepresentation and a
plaintiff’s injury.’” Erica P. John Fund, Inc. v. Halliburton Co.,
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not a prerequisite to recovery.
All that is necessary is that the
facts withheld be material in the sense that a reasonable investor
might have considered them important in the making of his decision.
. . . This obligation to disclose and the withholding of a material
fact establish the requisite element of causation in fact.’”
Regents of Univ. of Cal. v. Credit Suisse First Boston (USA), Inc.,
482 F.3d 372, 383-84 (5th Cir. 2007)(quoting Affiliated Ute Citizens
of the State of Utah v. U.S., 406 U.S. 128, 153-54 (1972)), cert.
denied sub nom. Regents of Univ. of Cal. v. Merrill Lynch, Pierce,
Fenner & Smith, 552 U.S. 1170 (2008).
See also Basic, Inc., 485
U.S. at 243 (“[W]here a duty to disclose material information had
been breached . . . the necessary nexus between the plaintiffs’
injury and the defendants’ wrongful conduct had been established.”).
“When an allegation of fraud is based upon nondisclosure,
there can be no fraud absent a duty to speak.”
Central Bank, 511
U.S. at 174, quoting Chiarella v. U.S., 445 U.S. 222, 235 (1980).
A duty to disclose arises only from “a fiduciary or other similar
relation of trust and confidence between [parties]”; it “does not
arise from the mere possession of nonpublic market information.”
Chiarella, 445 U.S. at 228, 235.
“Silence, absent a duty to
disclose, is not misleading under Rule 10b-5.”
Basic, Inc. v.
Levinson, 485 U.S. 224, 239 n.17 (1988).
563 U.S. 804, 810 (2011), quoting Basic, Inc., 485 U.S. 243.
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The omission of a material fact by a defendant with a duty
to disclose establishes a rebuttable presumption of reliance upon
the omission by investors to whom the duty was owed. Affiliated Ute
Citizens of the State of Utah v. U.S., 406 U.S. 126, 153-54 (1972).
omission, a plaintiff must (1) allege a case primarily based on
omissions or non-disclosure and (2) demonstrate that the defendant
owed him a duty of disclosure.”
Regent of Univ. of Cal., 482 F.3d
“This presumption is a judicial creature.
It responds to
the reality that a person cannot rely upon what he is not told.”
“[A]dministrative and judicial interpretations have established that
silence in connection with the purchase or sale of securities may
operate as a fraud actionable under § 10(b)” when there is “a duty
to disclose arising from a relationship of trust and confidence
between parties to a transaction.”
Chiarella, 445 U.S. at 230.
“Whether a fiduciary duty exists is a question of law for
the court’s determination.”
Stevenson v. Rochdale Investment
Management, Inc., No. Civ. A. 3:97CV1544L, 2000 WL 1278479, at *3
(N.D. Tex. Sept. 7, 2000), citing Fuqua v. Taylor, 683 S.W. 2d 735,
737 (Tex. App.--Dallas 1984, writ ref’d n.r.e.).
factfinder determines whether the facts give rise to a fiduciary
In Kinzbach Tool Co. v. Corbett-Wallace Corp., 138 Tex.
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565, 160 S.W. 2d 509, 512-13 (Tex. 1942), the Texas Supreme Court
The term “fiduciary” is derived from the civil
law. It is impossible to give a definition of
the term that is comprehensive enough to cover
all cases. Generally speaking, it applies to
any person who occupies a position of peculiar
confidence toward another.
It refers to
integrity and fidelity. It contemplates fair
dealing and good faith, rather than legal
obligation, as the basis of the transaction.
The term includes those informal relations
which exist whenever one party trusts and
relies upon another, as well as technical
See also Fisher v. Roper, 727 S.W. 2d 78, 81 (Tex. App.--San Antonio
1987, writ ref’d n.r.e.):
A fiduciary relationship exists when the
parties are under a duty to act for or give
advice for the benefit of another upon matters
within the scope of the relation. It exists
where a special confidence is reposed in
another who in equity and good conscience is
bound to act in good faith and with due regard
confidence. A fiduciary relationship generally
arises over a long period of time when parties
have worked together toward a mutual goal. To
evidence must show that the dealings between
the parties have continued for such a period of
time that one party is justified in relying on
the other to act in his best interest.
transform a mere contract into a fiduciary
relationship, the evidence must show that the
dealings between the parties have continued for
such a period of time that one party is
justified in relying on the other to act in his
best interest. [citations omitted].
For example, because of the relationship of trust and
- 20 -
confidence between the shareholders of a corporation and “those
insiders who have obtained confidential information by reason of
their position with that corporation,” courts have imposed a duty
to disclose on a corporate insider when the corporate insider trades
on the confidential information (“intended to be available only for
a corporate purpose and not for the personal benefit of anyone”) and
makes secret profits.
Chiarella, 445 U.S. at 227-28.
such [material, nonpublic] information qualifies as a ‘deceptive
device’ under § 10(b) . . . because ‘a relationship of trust and
confidence [exists] between the shareholders of a corporation and
those insiders who have obtained confidential information by reason
of their position with that corporation.’”
United States v.
O’Hagan, 521 U.S. 642, 651-52 (1997), citing Chiarella, 445 U.S. at
. . . gives rise to a duty to disclose [or
to abstain from trading] because of the ‘necessity of preventing a
corporate insider from . . . tak[ing] unfair advantage of . . .
O’Hagan, 521 U.S. at 652, quoting
Chiarella, 445 U.S. at 228-29.
A corporate insider with material
information is required to disclose it to the investing public or,
if he cannot because he must protect a corporate confidence, or if
he chooses not to disclose, he must abstain from trading in or
recommending securities concerned while the inside information
SEC v. Texas Gulf Sulphur Co., 401 F.2d 833,
848 (2d Cir. 1968)(en banc)(“[A]nyone in possession of material
- 21 -
inside information must either disclose it to the investing public,
or if he is disabled from disclosing it in order to protect a
corporate confidence, or he chooses not to do so, must abstain from
trading in or recommending the securities concerned while such
inside information remains undisclosed.”), cert. denied sub nom.
Kline v. SEC, 394 U.S. 976 (1969).
An individual or entity that does not fit within the
“temporary insider” if the person “by entering into a special
confidential relationship in the conduct of the business of the
enterprise is given access to information solely for corporate
SEC v. Cuban, 620 F.3d 551, 554 (5th Cir. 2010), citing
Dirks v. SEC, 463 U.S. 646, 655 n.13 (1983).
The duty to disclose
or abstain from trading arises from the corporate insider’s duty to
his shareholders, and it applies not only “to officers, directors
“attorneys, accountants, consultants and others who temporarily
become fiduciaries of the corporation.”
O’Hagan, 521 U.S. at 228-
29, quoting Dirks v. SEC, 463 U.S. 646, 655 n.14 (1983).
Violations of Rule 10b-5(a) and (c), which prohibit
“engag[ing] in any act, practice or course of business which
operates . . . as a fraud or deceit upon any person” in connection
with the sale of securities, were designated by some courts as
- 22 -
addressed the issue, “when, if ever, an injured investor may rely
upon § 10(b) to recover from a party that neither makes a public
misstatement nor violates a duty to disclose, but does participate
in a scheme to violate § 10(b).”
The high court rejected that
scheme liability theory because a plaintiff cannot rely on a
defendant’s concealed deceptive acts.
552 U.S. at 156, 159-60.
Justice Kennedy wrote for the majority,
Reliance by the plaintiff 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 “requisite
misrepresentation and a plaintiff’s injury”
exists as a predicate for liability. . . . We
have found a rebuttable presumption of reliance
in two different circumstances.
there is an omission of a material fact by one
with a duty to disclose, the investor to whom
the duty was owed need not provide specific
proof of reliance. . . . Second, under the
presumed when the statements at issue become
public. The public information is reflected in
the market price of the security. Then it can
be assumed that an investor who buys or sells
stock at the market price relies upon the
statement. . . .
Respondents had no duty to disclose; and their
deceptive acts were not communicated to the
public. No member of the investing public had
knowledge, either actual or presumed, of
respondents’ deceptive acts during the relevant
times. Petitioner, as a result, cannot show
reliance upon any of respondents’ actions
except in an indirect chain that we find too
remote for liability.
- 23 -
Id. at 769.
In Janus Capital Group, Inc. v. First Derivative Traders,
564 U.S. 135, 137-38, 142, 167 (2011)(5-4), examining what it means
to “‘make any untrue statement of material fact’ in connection with
the purchase or sale of securities” under Rule 10b-5 and “mindful
that [the Court] must give ‘narrow dimensions’” to the implied right
of action under § 10(b) since Congress did not authorize it,10 the
The majority of the Supreme Court began by construing
the word “make” in Rule 10b-5 very narrowly:
One “makes” a statement by stating it. When
“make” is paired with a noun expressing the
action of a verb, the resulting phrase is
“approximately equivalent in sense” to that
verb. 6 Oxford English Dictionary 66 (def.
instance, “to make a proclamation” is the
approximate equivalent of “to proclaim,” and
“to make a promise” approximates “to promise.”
See 6 OED 66 (def. 59). The phrase at issue
in Rule 10b-5, “to make any . . . statement.”
is thus the approximate equivalent of “to
In the dissent, Justice Breyer, joined by Justices Ginsburg,
Sotomayor, and Kagen, opined,
In my view, . . . the majority has incorrectly
interpreted the Rule’s word “make.” Neither
common English nor this Court’s earlier cases
limit the scope of that word to those with
“ultimate authority” over a statement’s
content. To the contrary, both language and
case law indicate that, depending upon the
circumstances, a management company, a board
of trustees, individual company officers, or
others, separately or together, might “make”
statements contained in a firm’s prospectus–even if a board of directors has ultimate
- 24 -
majority of the United States Supreme Court attempted to further
clarify the distinction between a primary violation and aiding and
abetting by holding, “For purposes of Rule 10b-5, the maker of a
statement is the person with ultimate authority over the statement,
including its content and whether and how to communicate it.
Without control, a person or entity can merely suggest what to say,
not ‘make’ a statement in its own right.
One who prepares or
publishes a statement on behalf of another is not its maker.”11
also Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398,
2403 (2014)(Section 10(b) and Rule 10b-5 liability should not be
extended “to entirely new categories of defendants who themselves
had not made any material public misrepresentation.”).
restricts liability under a § 10(b) private right of action to a
person or entity with ultimate authority over a false statement on
which an investor relied to his detriment in purchasing or selling
The PSLRA “installed both substantive and procedural
controls” that were “[d]esigned to curb perceived abuses of the §
Id., 564 U.S. at 149-50.
The high court compared the relationship between the
aider and abettor and the primary violator to that between a
speechwriter and a speaker: “Even when a speechwriter drafts a
speech, the content is entirely within the control of the person
who delivers it. And it is the speaker who takes credit--or blame-for what is ultimately said.” Id. at 143.
- 25 -
defendants, vexatious discovery requests and manipulation by class
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551
U.S. 208, 320 (2007).
The PSLRA heightened the particularity
requirements for pleading securities fraud in two ways:
misleading and the reason or reasons why the statement is misleading
. . .,” 15 U.S.C. § 78u-4(B)(1)(B); and (2) for “each act or
omission alleged” to be false or misleading, the plaintiff must
“state with particularity facts giving rise to a strong inference
that the defendant acted with the required state of mind,” 15 U.S.C.
Indiana Elec. Workers’ Pension Trust Fund IBEW v.
Shaw Group, Inc., 537 F.3d 527, 533 (5th Cir. 2007).
As noted, Rule
9(b) requires the plaintiff in a securities fraud suit to “‘specify
the statements contended to be fraudulent, identify the speaker,
state when and where the statements were made, and explain why the
statements were fraudulent.’”
Southland, 365 F.3d at 362, quoting
Williams v. WMX Technologies, Inc., 112 F.3d 175, 177-78 (5th Cir.
1997), cert. denied, 522 U.S. 966 (1997).
See 15 U.S.C. § 78u-4.
In other words, “‘[p]leading fraud with particularity . . . requires
‘time, place and contents of the false representations, as well as
the identity of the person making the misrepresentation and what
[that person] obtained thereby.’”
Williams, 112 F.3d at 177 (5th
Cir. 1997), quoting Tuchman, 14 F.3d at 1068.
- 26 -
The PSLRA mandates
that “untrue statements or omissions be set forth with particularity
as to ‘the defendant’ and that scienter be pleaded with regard to
‘each act or omission’ sufficient to give ‘rise to a strong
inference that the defendant acted with the required state of
Southland, 365 F.3d at 364.
The PSLRA’s use of “the
defendant” is reasonably construed to mean “‘each defendant’ in
multiple defendant cases.’”
Id. at 365.
Where the defendant is a
corporation (as Warburg and PW are), the plaintiff must plead
specific facts giving rise to a strong inference that a particular
omission; “[a] defendant corporation is deemed to have the requisite
scienter for fraud only if the individual corporate officer making
the statement has the requisite level of scienter, i.e., knows the
statement is false, or at least deliberately reckless as to its
falsity, at the time he or she makes the statement.” Southland, 365
F.3d at 366.
“‘The knowledge necessary to form the requisite
fraudulent intent must be possessed by at least one agent [of the
corporation] and cannot be inferred and imputed to a corporation
based on disconnected facts known by different agents.’”
367, quoting Gutter v. E.I. Dupont De Nemours, 124 F. Supp. 2d 1291,
1311 (S.D. Fla. 2000); also citing First Equity Corp. v. Standard
& Poor’s Corp., 690 F. Supp. 256, 260 (S.D.N.Y. 1988)(“A corporation
can be held to have a particular state of mind only when that state
of mind is possessed by a single individual.”), aff’d, 869 F.2d 175
- 27 -
(2d Cir. 1989).
“‘In cases concerning . . . omission of facts, Rule 9(b)
typically requires the claimant to plead the type of facts omitted,
the place in which the omissions should have appeared, and the way
in which the omitted facts made the representations misleading.’”
Carroll v. Fort James Corp., 470 F.3d 1171, 1174 (5th Cir. 2006),
quoting United States ex. rel. Riley v. St. Luke’s Hosp., 355 F.3d
370, 381 (5th Cir. 2004).
To meet the requirement of materiality,
“there must be a substantial likelihood that the disclosure of the
omitted fact would have been viewed by the reasonable investor as
having significantly altered the ‘total mix’ of information made
deliberations of the reasonable shareholder.” Basic, Inc., 485 U.S.
at 231-32; Southland, 365 F.3d at 362.
See also Lormand v. US
Unwired, Inc., 565 F.3d 228, 248-49 (5th Cir. 2009)(“Once the
defendants engaged in public discussion . . ., they had a duty to
disclose a ‘mix of information’ that is not misleading.”). Thus the
standard for misrepresentation in this context is whether the
information disclosed, understood as a whole, would mislead a
reasonable potential investor. L.W. Laird v. Integrated Resources,
Inc., 897 F.2d 826, 832 (5th Cir. 1990).
The Fifth Circuit has
“long held under Rule 10b-5, a duty to speak the full truth arises
when a defendant undertakes a duty to say anything.
defendant is under no duty to disclose every fact or assumption
- 28 -
underlying a prediction, he must disclose material, firm-specific
adverse facts that affect the validity or plausibility of that
Lormand, 565 F.3d at 249.
“The omission of a known
risk, its probability of materialization, and its anticipated
magnitude, are usually material to any disclosure discussing the
prospective result from a future course of action.”
Id. at 248
These facts “must be laid out before access to the discovery process
Williams, 112 F.3d at 178.
The Fifth Circuit does not permit group pleading of
securities fraud suits.
Owens v. Jastrow, 789 F.3d 529, 537 (5th
Cir. 2015), citing Southland, 365 F.3d at 365 (“[T]he PSLRA requires
the plaintiffs to distinguish among those they sue and enlighten
each defendant as to his or her particular part in the alleged
fraud. . . . [W]e do not construe allegations contained in the
[second amended complaint] against ‘defendants’ as a group as
properly imputable to any particular defendant unless the connection
between the individual defendant and the allegedly fraudulent
statement is specifically pleaded.”).12 “Corporate officers are not
The group pleading or group publishing doctrine permits
plaintiffs to presume that statements in prospectuses, registration
statements, annual reports, press releases, etc. are collectively
attributable to persons with direct involvement in the regular
business of the company. Southland, 365 F.3d at363 n.9. In its
most expansive form it allows “unattributed corporate statements
to be charged to one or more individual defendants based solely on
their corporate title. Under this doctrine, the plaintiff need not
allege any facts demonstrating an individual defendant’s
participation in the particular communication containing the
- 29 -
liable for acts solely because they are officers or where their dayto-day involvement in the corporation is pleaded.”
Acquisition Partners LP v. Blackwell, 440 F.3d 278, 287 (5th Cir.
A corporate officer may be liable if plaintiff identifies
him and alleges he made materially misleading statements with
scienter at a shareholder meeting or he signed documents on which
statements were made.
Group pleading, or the group publishing
doctrine, fails to satisfy the heightened pleading standards of the
Southland, 365 F.3d at 363 n.9.13
The Fifth Circuit further requires that scienter or the
requisite state of mind, which for the PSLRA is ”an intent to
deceive, manipulate, or defraud,” or “‘severe recklessness’ in which
the ‘danger of misleading buyers or sellers . . . is either known
to the defendant or is so obvious that the defendant must have been
misstatement or omission where the defendants are ‘insiders or
affiliates’ of the company.” Id. at 363.
The Third Circuit, which includes Delaware, has also
held that “the group pleading doctrine is no longer viable in
private securities actions after the enactment of the PSLRA.”
Winer Family Trust v. Queen, 503 F.3d 319, 334 (3d Cir. 2007). See
also City of Roseville Employees’ Retirement v. Horizon Lines,
Inc., 686 F. Supp. 2d 404, 426 (D. Del. 2009)(“[T]o plead scienter
against the corporate defendants, plaintiffs must identify facts
raising a strong inference that false or misleading statements were
made or otherwise promoted by an individual acting on behalf of
each company and who knew or was reckless in not knowing that the
statements were false or misleading at the time they were made.”
- 30 -
aware of it,’”14 must be pleaded for each act or omission for each
defendant in a multiple defendant case sufficiently to create “a
strong inference that the defendant acted with the required state
Id. at 364-65.
See also Owens v. Jastrow, 789 F.3d at
536 (“Severe recklessness is limited to those highly unreasonable
omissions or misrepresentations that involve not merely simple or
inexcusable negligence, but an extreme departure from the standard
of ordinary care, and that present a danger of misleading buyers or
sellers which is either known to the defendant or is so obvious that
the defendant must have been aware of it.”), quoting Abrams v. Baker
Hughes, Inc., 292 F.3d 424, 430 (5th Cir. 2002).
whether a statement made by a corporation was made with the
requisite intent, it is appropriate to look into the state of mind
of the corporate official who made the statement rather than to the
collective knowledge of all of the corporation’s officers and
employees acquired in the course of their employment.
365 F.3d at 366; Janus Capital Group, Inc. v. First Derivative
Traders, 564 U.S. 135, 142 (2011)(“[T]he maker of a statement is the
including its content and whether and how to communicate it.”).
defendant corporation is deemed to have the requisite scienter for
fraud only if the individual corporate officer making the statement
Quoting Broad v. Rockwell Int’l Corp., 642 F.2d 929,
Cir. 1981)(en banc).
- 31 -
has the requisite level of scienter, i.e., knows that the statement
is false or is at least deliberately reckless as to its falsity, at
the time he or she makes the statement.”
Southland, 365 F.3d at
“In determining whether the pleaded facts give rise to a
‘strong’ inference of scienter, the court must take into account
plausible opposing inferences.”
Tellabs, Inc. v. Makor Issues &
Rights, Ltd., 551 U.S. 308, 323 (2007).
Furthermore, the inference
of scienter ultimately must be “‘cogent and compelling,’ not merely
‘reasonable’ or “permissible.’”
“Congress required plaintiffs to
plead with particularity facts that give rise to a ‘strong’--i.e.,
a powerful or cogent--inference.”
Id.; Indiana Elec. Workers’
Pension Trust Fund IBEW v. Shaw Group, Inc., 537 F.3d 527, 533 (5th
Cir. 2008), quoting Tellabs, Inc., 551 U.S. at 324.
whether the plaintiff has alleged facts that give rise to the
requisite ‘strong inference’ of scienter, a court must consider
plausible, nonculpable explanations for the defendant’s conduct, as
well as inferences favoring the plaintiff.
The inference that the
defendant acted with scienter need not be irrefutable, i.e., of the
‘smoking-gun’ genre, or even the ‘most plausible of competing
Id. at 323-24.
But it must be “at least as
compelling as any opposing inference one could draw from the facts
Id. at 324.
“[A] tie favors the plaintiff.” Owens v.
Jastrow, 789 F.3d 529, 536 (5th Cir. 2015), quoting Lormand v. US
- 32 -
Unwired, Inc., 565 F.3d 228, 254 (5th Cir. 2009), citing Tellabs,
551 U.S. at 324. “The inquiry is whether all of the facts alleged,
taken collectively, give rise to a strong inference of scienter, not
whether any individual allegations, scrutinized in isolation, meet
Lormand, 565 F.3d at 251, citing Tellabs, 551 U.S.
While allegations of motive and opportunity may serve
to strengthen the inference of scienter, such allegations alone are
insufficient to satisfy the requirement.
Flaherty & Crumrine
Preferred Income Fund, Inc. v. TXU Corp., 565 F.3d 200, 208 (5th
Cir. 2009); Owens v. Jastrow, 789 F.3d at 539.
defendant’s motion to dismiss, ‘dismiss the complaint.’” Nathenson,
267 F.3d at 407, citing § 78u-4(b)(3).
Under the PSLRA, 15 U.S.C. § 78u-4(b)(4), a plaintiff must
also allege and ultimately prove “the traditional elements of
causation and loss,” i.e., “that the defendant’s misrepresentations
(or other fraudulent conduct) proximately caused the plaintiff’s
economic loss.” Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336,
The plaintiff must plead economic loss and loss
misrepresentation or omission and the loss.
Id. at 341-42.
inflated purchase price will not itself constitute or proximately
cause the relevant loss.”
Id. at 342.
- 33 -
To establish proximate
causation, the plaintiff must prove that when the “relevant truth”
about the fraud began to leak out or otherwise make its way into the
marketplace, it caused the price of the stock to depreciate and
thereby proximately cause the plaintiff’s economic injury. Lormand,
565 F.3d at 255 (“[W]e conclude that Rule 8(a)(2) requires the
plaintiff to allege, in respect to loss causation, a facially
‘plausible’ causal relationship between the fraudulent statements
or omissions and plaintiff’s economic loss, including allegations
of a material misrepresentation or omission, followed by the leaking
out of relevant or related truth about the fraud that caused a
significant part of the depreciation of the
stock and plaintiff’s
economic loss.”), citing Dura at 342, 346.
Both the 1933 and the 1934 statutes have a section
imposing liability on persons controlling a primary violator.
Section 15, 15 U.S.C. § 77o of the 1933 Act, entitled “Liability of
controlling persons, states in relevant part,
(a) Controlling persons
Every person who, by or through stock
ownership, agency, or otherwise, or who,
pursuant to or in connection with an agreement
or understanding with one or more persons by or
through stock ownership, agency, or otherwise,
controls any person liable under sections 77k
or 77l of this title, shall also be jointly and
severally with and to the same extent as such
controlled person to any person to whom such
controlled person is liable, unless the
controlling persons had no knowledge of or
reasonable ground to believe in the existence
of the facts by reason of which the liability
- 34 -
of the controlled person is alleged to exist.
(b) Prosecution of persons who aid and abet
For purposes of any action brought by the
Commission under subparagraph (b) or (d) of
section 77t of this title, any person
knowingly or recklessly provides substantial
assistance to another person in violation of a
provision of this subchapter, or of any rule or
regulation issued under this subchapter, shall
be deemed to be in violation of such provision
to the same extent as the person to whom such
assistance is provided.15
“The term control (including the terms controlling, controlled by
and under common control with) means the possession, direct or
indirect, of the power to direct or cause the direction of the
management and policies of a person, whether through the ownership
of voting securities, by contract, or otherwise.”
17 C.F.R. §
To state a claim for Section 15 control person liability,
a plaintiff must allege that a primary violation under Section 11
or 12 was committed and the defendant directly or indirectly
controlled the violator.
Kapps v. Torch Offshore, Inc., 379 F.3d
207, 221 (5th Cir. 2004).
The plaintiff can show control by
alleging facts showing that the defendant possessed the power to
direct or cause the direction of the management and policies of a
Plaintiffs assert that Defendants are liable for their
employees’ conduct under the common law doctrine of respondeat
superior, as well as under § 15 of the Securities Act on 1933, 15
U.S.C. § 77(o), and under § 20 of the Securities Exchange Act of
1934, 15 U.S.C. § 78(t).
- 35 -
person through ownership of voting securities, by contract, business
relationships, interlocking directors, family relations, or the
power to influence and control the activities of another, but the
plaintiff must allege more than the defendant’s position or title.
In re Dynegy, Inc. Sec. Litig., 339 F. Supp. 2d 804, 828 (S.D. Tex.
The Fifth Circuit does not require a plaintiff to allege
that the controlling person actually participated in the underlying
primary violation to state a claim for control person liability.
78(t)(“Liability of controlling persons and persons who aid and
Every person who, directly or indirectly,
controls any person liable under any provision
of this title or of any rule or regulation
thereunder shall also be liable jointly and
severally with and to the same extent as such
controlled person to any person to whom such
controlled person is liable . . ., unless the
controlling person acted in good faith and did
not directly or indirectly induce the act of
acts constituting the violation or cause of
Claims under section 20(a) are not governed by Rule 9(b)’s
heightened pleading requirements for fraud claims; plaintiffs need
only give the defendant fair notice of the claim and the grounds for
In re BP p.l.c. Litig., 843 F. Supp. 2d 712, 791
(S.D. Tex. 2012).
Plaintiffs can state a claim of controlled
persons against corporate officers who did not personally make a
misrepresentation or play a significant role in the preparation of
- 36 -
nevertheless “had the requisite power to directly or indirectly
control or influence corporate policy.”
Id. at 792, quoting G.A.
Thompson & Co., 636 F.2d 945, 958 (5th Cir. 1981).
Because § 20(a) is a secondary liability provision, if the
Plaintiff fails to state a claim for a primary violation under §
10(b) and/or Rule 10b-5, Plaintiff also fails to state a claim for
control person liability under § 20(a).
Id. at 750.
The control person liability provisions of Section 20(a)
of the 1934 Act and Section 15 of the 1933 Act, although worded
differently, are interpreted similarly. Dynegy, 339 F. Supp. 2d at
828, citing Abbot v. Equity Group, Inc., 2 F.3d 613, 619 n.15 (5th
Cir. 1993); In re Franklin Bank Sec. Litig., 782 F. Supp. 2d 364,
380 (S.D. Tex. 2011), aff’d sub nom. Harold Roucher Trust U/A DTD
9/21/72 v. Nocella, 464 Fed. Appx. (5th Cir. Mar. 14, 2012).
Securities Act of 1933
The 1933 Act, 15 U.S.C. §§ 77a et seq., governs the
The Securities Act of 1933 also bars the “offer or sale”
of “securities” unless a registration statement has been filed with
the SEC or an exception to registration requirements applies.
Section 5 of the 1933 Act, 15 U.S.C. § 77e; SEC v. Continental
Tobacco Co., 463 F.2d 137, 155-56 (5th Cir. 1972).
- 37 -
Section 11, 15 U.S.C. § 77k, addressing “Civil liabilities
on account of false registration statement,” provides purchasers of
registered securities with strict liability protection for material
misstatements or omissions in registration statements with the SEC
by specifically enumerated parts.
It provides in relevant part,
(a) In case any part of the registration
statement . . . contained an untrue statement
of a material fact or omitted to state a
material fact required to be stated therein or
necessary to make the statement therein not
misleading, any person acquiring such security
(unless it is proved that at the time of such
acquisition he knew of such untruth or
omission) may, either at law or in equity, in
any court of competent jurisdiction, sue
(2) every person who was a director
of (or person performing similar
functions) or partner in the issuer
at the time of the filing of the part
of the registration statement with
respect to which his liability is
(3) every person who, with his
consent, is named in the registration
statement as being or about to become
a director, person performing similar
functions or partner; . . . .
(5) every underwriter to such security.
Regarding (5), under Section 2(11), 15 U.S.C. § 77b(11),
a statutory underwriter is defined functionally on the basis of its
relationship to a particular offering and reaches “any person who
has purchased from an issuer with a view to, or offers or sells for
- 38 -
an issuer in connection with, the distribution of any security, or
participates or has direct or indirect participation in any such
undertaking, or participates or has a participation in the direct
Furthermore 15 U.S.C. § 77k(a)(5) provides that any person who
purchases a security, which was subject to a registration statement
containing a false statement, may sue “every under writer with
respect to such security.”
Section 12, 15 U.S.C. § 77l, states in relevant part,
(a) in general-–Any person who–
(1) offers or sells a security in
violation of section 77e of this title, or
(2) offers or sells a security (whether or
not exempted by the provisions of section
77c of this title, other than paragraphs
(2) and (14) of subsection (a) of said
section), by the use of any means or
communication in interstate commerce or of
the mails, by means of a prospectus or
oral communication, which includes an
necessary in order to make the statements,
in light of the circumstances under which
they were made, not misleading (the
purchaser not knowing of such untruth or
omission), and who shall not sustain the
burden of proof that he did not know, and
in the exercise of reasonable care could
not have known, or such truth or omission,
shall be liable, subject to subsection (b) of
this section, to the person purchasing such
security from him, who may sue either at law or
in equity any court of competent jurisdiction,
to recover the consideration paid for such
- 39 -
security with interest thereon, less the amount
of any income received thereon, upon the tender
of such security, or for damages if he no
longer owns the security.
Section 11 of the Securities Act of 1933, 15 U.S.C. § 77k,
“applies to registered securities and imposes civil liability on the
signatories to the registration statement and on the directors of
the issuer when the registration statement is materially misleading
Firefighters Pension & Relief Fund of the City of
New Orleans v. Bulmahn, 53 F. Supp. 3d 882, 892 (E.D. La. 2014),
citing Rosenzweig v. Azurix Corp. 332 F.3d 854, 861 (5th Cir. 2003).
To state a claim under Section 11 of the Securities Act of 1933, 15
U.S.C. § 77k, the plaintiffs must allege that they purchased shares
from a registration statement that contained (1) an omission or
misstatement (2) of a material fact required to be stated or
necessary to make other statements made not misleading.
Banc Texas Group, Inc., 989 F.2d 1435, 1445 (5th Cir. 1993)(defining
a “material fact” as “one which a reasonable investor would consider
significant in the decision whether to invest, such that it alters
Thus section 11, 15 U.S.C. § 77k(a), permits “any person
acquiring such security” to sue, including after market purchasers
- 40 -
of shares issued in a public offering,16 while in contrast, under
section 12(a)(2), 15 U.S.C. § 77l(a)(2), a seller is only liable “to
the person purchasing such security from him.” Rosenzweig, 332 F.3d
at 872-73, citing inter alia Joseph v. Wiles, 223 F.3d 1155, 1159
(10th Cir. 2000)(“[T]he natural reading of ‘any person acquiring
such security’ is simply that the buyer must have purchased a
security issued under the registration statement at issue, rather
than some other registration statement.”).
Regarding alleged omissions, under § 11 an issuer only has
to disclose information that is required to make other statements
not misleading or information that the securities laws require to
be disclosed; simply possessing material nonpublic information does
not give rise to a duty to disclose.
Firefighters, 53 F. Supp. 3d
Moreover the statute’s “‘expansive’ liability provisions
create ’virtually absolute liability’ for corporate issuers for even
innocent misstatements.” Id., quoting Krim v. pcOrder.com, Inc., 402
F.3d 489, 495 (5th Cir. 2205).
Plaintiffs are not required to plead
scienter, reliance or fraud under the statute.
Id., citing Rombach
Where grounded in negligence, Section 11 only requires
notice pleading under Federal Rule of Civil Procedure 8, not the
See Rosenzweig, 332 F.3d at 872 (“§ 11 applies to
Section 11 only applies to public
registered offerings, and not to private offerings. Id. at 873.
- 41 -
heightened standards of Federal Rule of Civil Procedure 9(b) or of
In re Dynegy, Inc. Sec. Litig., 339 F. Supp. 2d 804,
(averments that defendants made untrue statements of material facts
and omitted to state material facts in violation of § 11 are not
claims that sound in fraud and cannot be dismissed for failure to
satisfy Rule 9(b)’s heightened pleading requirements), citing In re
Electronic Data Systems Corp. “ERISA” Litig., 205 F. Supp. 2d 658,
677 (E.D. Tex. 2004).
Nor is a plaintiff required to allege and
show that the defendant acted with scienter under § 11 of the
Securities Act of 1933, 15 U.S.C. § 77k(a), or that he relied in any
way on the defendant’s misrepresentations or omissions.
268 F. Supp.2d at 756 (S.D. Tex. 2003).
Nevertheless, if the
allegations are based in fraud, the heightened standards of Rule
Firefighters, 53 F. Supp. 3d at 892, citing Lone Star
Ladies Inv. Club, 238 F.3d at 368, citing Melder, 27 F.3d at 1100
n.6, and Rombach, 355 F.3d at 171.
“The Securities Act of 1933 imposes strict liability on
purchasers to recover under Section 12(1) “regardless of whether
they can show any degree of fault, negligent or intentional, on the
Swenson v. Engelstad, 626 F.2d 421, 424-25 (5th
An issuer’s liability to a plaintiff who buys a
security issued pursuant to a registration statement with a material
- 42 -
misstatement or omission under section 12 (as it is under section
11) of the 1933 Act is “‘virtually absolute.’”
Lone Star Ladies
Inv. Club v. Scholtzsky’s Inc., 238 F.3d 263, 369 (5th Cir. 2001),
quoting Herman & MacLean v. Huddleston, 459 U.S. 375, 382 (1983).
In Pinter v. Dahl, 486 U.S. 622, 644 (1988), the Supreme Court
indicate that in some situations the issuer is immune from liability
in a firm commitment underwriting [where the public does not
important consequence of [the purchaser clause] is that § 12(1)
imposes liability on only the buyer’s immediate seller; remote
purchasers are precluded from bringing actions against remote
sellers. Thus a buyer cannot recover against his seller’s seller.”
Lone Star Ladies Inv. Club v. Schlotzsky’s, Inc., 238 F.3d 363, 370
(5th Cir. 2001), quoting Pinter, 486 U.S. at 644 n.21 (emphasis
added by Lone Star).
Furthermore § 12(a)(2) applies only to
purchases of stock in initial offerings, and not to aftermarket
Gustafson v. Alloyd Co., Inc., 513 U.S. 561 (1995).
also Rosenzweig v. Azurix Corp., 332 F.3d 854, 870-71 (5th Cir.
2003)(holding that purchasers who buy their shares on the secondary
market lack standing to bring § 12(a)(2) claims.).
Defendants other than the issuer can avoid liability by pleading
and proving an affirmative defense of due diligence.
Section 12 restricts recovery to purchasers who purchase
- 43 -
their shares from a seller who makes use of false or misleading
15 U.S.C. § 77l(a)(2)(seller “shall be liable to the
person purchasing such security from him.”).
“Section 2(3) defines
‘sale’ or ‘sell’ to include ‘every contract of sale or disposition
of a security or interest in a security, for value,’ and the terms
‘offer to sell,’ ‘offer for sale,’ or ‘offer’ to include ‘every
attempt or offer to dispose of, or solicitation of an offer to buy,
a security or interest in a security, for value.’
15 U.S.C. §
77(b)(3). Under these definitions, the range of persons potentially
liable under § 12(1) is not limited to persons who pass title.”
Pinter v. Dahl, 486 U.S. 622, 643 (1988).
While the purchase
requirement limits liability to instances in which a sale has
occurred, the language of the statute extends statutory seller
status and thus liability to some persons who simply urged the buyer
to purchase the security.
Id. at 644.
When a broker acting as an agent of one of the principles
to a securities purchase successfully solicits a purchase, he is a
person from whom the buyer purchases within the meaning of § 12 and
is thus liable as a statutory seller.
Pinter, 486 U.S. at 646,
Cir.)(finding a broker acting as an agent to be liable as a
statutory seller), cert. denied, 311 U.S. 705 (1940).
Court went on to limit a solicitor’s liability to exclude the
solicitor, “merely to assist the buyer,” “gratuitously urges another
- 44 -
to make a particular investment”:
“The language [‘buy . . . for
value”] and purpose of § 12(1) suggest that liability extends only
to the person who successfully solicits the purchase, motivated at
least in part by a desire to serve his own financial interests or
those of the securities owner,” e.g., a broker.
Id. at 647.
As with § 11, where § 12(a) claims do constitute fraud,
the plaintiff must plead the circumstances constituting fraud with
Rule 9(b) particularity.
Collmer v. U.S. Liquids, Inc., 268 F.
Supp.2d 718, 756 (S.D. Tex. 2003), citing Melder v. Morris, 27 F.3d
1097, 1100 n.6 (5th Cir. 1994)(“When 1933 Securities Act claims are
grounded in fraud rather than negligence . . . Rule 9(b) applies.”).
Section 12(a)(2) of the Securities Act of 1933, 15 U.S.C.
§ 77l(a), states, “Any person who . . . offers or sells a security
. . . by means of a prospectus or oral communication, which includes
an untrue statement of material fact or omits to state a material
fact necessary in order to make the statements, in light of the
circumstances under which they were made, not misleading (the
purchaser not knowing of such untruth or omission), and who shall
not sustain the burden of proof that he did not know, and in the
exercise of reasonable care could not have known, of such untruth
or omission, shall be liable, subject to subsection (b) of this
section, to the person purchasing such security from him, who may
jurisdiction, to recover the consideration paid for such security
- 45 -
with interest thereon, less the amount of any income received
therein, upon the tender of such security, or for damages if he no
longer owns the security.” Under section 12(a)(2) the term “seller”
refers to “either the person who actually passes title to the buyer,
or ‘the person who successfully solicits the purchase, motivated at
least in part by a desire to serve his own financial interests or
those of the securities owner,’ e.g., a broker.”
Azurix Corp., 332 F.3d 853, 871 (5th Cir. 2003), citing Pinter v.
Dahl, 486 U.S. 622, 647 (1988).
To constitute a “solicitation,” at
the very least the seller must “directly communicate with the
Id., citing Litigation v. Kraftsow, 890 F.2d 628, 636 (3d
participation in the solicitation of the immediate sale to hold the
issuer liable as a § 12(a)(2).”).
To prevail on a claim under § 12(a)(2), 15 U.S.C. §
77l(a)(2), the plaintiff must allege and prove that the defendant,
as a seller of a security “by means of a prospectus or oral
communication,” misrepresented or failed to state material facts to
the plaintiff in connection with the sale and that the plaintiff had
no knowledge of untruth or omission.
Collmer, 268 F. Supp.2d at
756, citing Junker v. Crory, 650 F.2d 1349, 1359 (5th Cir. 1981).
As with § 11, “a ‘material’ fact is one which a reasonable investor
would consider significant in the decision whether to invest, such
that it alters the ‘total mix’ of information available about the
- 46 -
Krim, 989 F.2d at 1445.
There is no liability under Section 12(a)(2) if there
In re Morgan Stanley Technology Fund Sec. Litig., 643
F. Supp. 2d 366, 381-82 (S.D.N.Y. 2009), citing In re Time Warner
Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir. 1933)(an actionable claim
under the Securities Act or the Exchange Act must plead a material
omission that involves information that the defendant has a duty to
Employee Stock Option Plans
To have standing to sue under the 1933 and 1934 Acts, a
plaintiff must be either a purchaser or a seller of the securities
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723
(1975). Therefore for the securities laws to apply to a transaction
between the employer and the employee, there must be a “security”
and a “sale.”
To determine whether a stock option plan is covered
by the securities laws, the Court first examines whether the
employee’s interest in the plan is a “security,” second, whether it
involves an “offer” or “sale” of securities, and third, whether it
falls within an exemption from either or both of the Acts.
It is undisputed that a stock option is a security.
Section 2(1) of the Securities Act of 1933, 15 U.S.C. § 77b(a)(1),
and Section 3(a)(1) of the Exchange Act, 15 U.S.C. § 78c(a)(10),
define a “security” almost identically, with the variations being
- 47 -
insignificant here, to include inter alia any note, stock, bond,
option, and participation in an investment contract.
SEC v. Glenn
W. Turner Enterprises, Inc., 474 F.2d 476, 480 & n.4 (9th Cir.
1973), cert. denied,414 U.S. 821 (1973); Hunssinger v. Rockford
Business Credits, Inc., 745 F.2d 484, 487 (7th Cir. 1984); Daily v.
Morgan, 701 F.2d 496. 500 (5th Cir. 1983)(“‘Stock’ is expressly
included in the definition [of ‘security’ in the 1933 and 1934
Acts], and represents to many people, both trained and untrained in
Orthomolecular Nutrition Institute, Inc., 751 F.2d 555, 558 (2d Cir.
employment qualifies as a purchase or sale of securities under the
Securities Exchange Act).
An “investment contract” under the federal securities acts
is a contract, transaction or scheme in which a person invests money
in a common enterprise and is led to expect profits solely from the
efforts of the promoter or a third party.
15 U.S.C. § 77b(1) and
Because the Securities Acts are remedial in nature
and were enacted to regulate investments in an effort to protect
against abuses in the securities market, the Supreme Court opined
that the broad definition of securities “encompasses virtually any
instrument that might be sold as an investment” and “embodies a
flexible rather than a static principle, one that is capable of
adaptation to meet the countless and variable schemes devised by
- 48 -
those who seek the use of the money of others on the premise of
Reves v. Ernst & Young, 494 U.S. 56, 60-61 (1990); SEC
v. W.J. Howey Co., 328 U.S. 293, 299 (1946).
“investment contract,” i.e., “whether a contract transaction or
scheme whereby a person invests his money in a common enterprise and
is led to expect profits solely from the efforts” of others.
In applying the test, courts should disregard form and
focus on the “substance–-the economic realities of the transaction-rather than the names that may have been employed by the parties.”
United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 848-49
In Howey the Supreme Court determined, regarding the first
prong, the investment of money, that the employees covered under the
defined benefit17 pension plan did not make an “investment of
Employee benefit plans are divided into two broad
categories: defined benefit and defined contribution plans. The
SEC explains in Employee Benefit Plans, SEC Release No. 33-6188,
19 S.E.C. Docket 465, 1980 WL 29482, at *6-7,
A defined benefit plan pays fixed or
ordinarily are described in a formula which
specifies the amount payable in monthly or
annual installments to participants who retire
at a certain age. As long as the plan and the
employer(s) contributing to the plan remain
solvent, and the plan continues to be operate,
vested participants will receive the benefits
In the event the investment
results of the plan do not meet expectations,
- 49 -
money,” unlike other purchasers who had given up “some tangible and
definable consideration” in return for their security”; in a pension
compensation other than the potential pension benefits has any of
the characteristics of a security. . . Only in the most abstract
sense may it be said that an employee ‘exchanges’ some portion of
his labor in return for there possible benefits.” Int’l Brotherhood
of Teamsters, Chauffeurs, Warehousemen and Helpers of America v.
the employer(s) usually will be required, on
the basis of actuarial computation, to make
additional contributions to fund the promised
Conversely, if plan earnings are
better than anticipated, the employer(s) may
be permitted to make contributions that are
less than the projected amounts.
A defined contribution plan does not pay any
fixed or determinable benefits.
benefits will vary, depending on the amount of
plan contributions, the investment success of
the plan, and allocations made of benefits
forfeited by non-vested participants who
Thus, the amount of
benefits is based, in part, on the earning
generated by the plan.
Observing that the opinion in Int’l Brotherhood of Teamsters,
Chauffeurs, Warehouseman & Helpers of America v. Daniel, 439 U.S.
551 (1979)(discussed infra). “did not rest on the fact that the
plan was a defined benefit one,” the SEC finds that the “defined
benefit or defined contribution nature of a plan is not dispositive
in determining whether a security is present.” Id. at *7.
- 50 -
Daniel, 439 U.S. 551, 560-61 (1979).18
Nor was the second prong of
the Howey test met because the pension plan’s funds were mainly
Id. at 562 (“[A] far larger portion of its
income comes from employer contributions,” and not from earnings
from its assets).
Because any profit made from the pension plan’s
investment of those monies was minimal and the covered employees
would not gain or lose from the choice of those investments, the
high court found that the fund was not a “common enterprise with
profits to come solely from the efforts of others,” and thus it was
not an investment contract.
Id. at 558, quoting Howey, 328 U.S. at
301. Finally the Supreme Court found that ERISA, which specifically
regulates pension plans, undermined any reason for securities
regulations of such pension plans.
Id. at 569-70.
After Howey, in Daniel the Supreme Court applied the Howey
test to decide whether an employee’s interest in an employee pension
plan constituted a “security” under the 1934 Act. It concluded that
the answer depended on whether the plan is voluntary or compulsory,
individually contributory or noncontributory.19 Daniel, 439 U.S. at
The Supreme Court noted in Daniel, 439 U.S. at 559, “An
employee who participates in a noncontributory, compulsory pension
plan by definition makes no payment into the pension fund. He only
accepts employment, one of the conditions of which is eligibility
for a possible benefit on retirement.”
In Daniel the plan was compulsory because all employees
were enrolled in it under a collective bargaining agreement and it
was noncontributory because the employer alone paid money into it.
- 51 -
559; Employee Benefit Plans, SEC Release No. 33-6188, 1 Fed. Sec.
Rep. (CCH) P 1051 at 2073-6 n, 19-20, 1980 WL 29482 (Feb. 1, 1980).
A “compulsory” benefit indicates the employer imposed the benefit
as a condition of employment (i.e., all employees were required to
participate), while “noncontributory means that “[t]he employees
paid nothing to the plan themselves,” and the employer made all the
Observing that every Supreme Court decision finding
the existence of a security under the 1933 and 1934 Acts also found
an investor who “chose to give up a specific consideration in return
for a separable financial interest with the characteristics of a
security” or a purchaser who “gave up some tangible and definable
characteristics of a security,” the Supreme Court found that in
insignificant part of an employee’s total compensation package.”
439 U.S. at 560.
“Only in the most abstract sense may it be said
that an employee ‘exchanges’ some portion of his labor in return for
these possible benefits.”
Id. “Looking at the economic realities,
it seems clear that an employee is selling his labor primarily to
obtain a livelihood, not making an investment.”
Id. at 559-60.20
Inducements to continue employment (in contrast to
inducements to accept employment) are not seen as a contribution
sufficient to constitute a “security” to meet the test. In re
Cendant Corp. Sec. Litig., 81 F. Supp. 2d 550, 556 (D.N.J.
2000(“When an employee does not give anything of value for stock
other than the continuation of employment not independently
- 52 -
Daniel held that an interest in a compulsory, noncontributory
pension plan is not an interest in an investment contract, and thus
not a “security” under the 1933 and 1934 Acts.
Daniel, 439 U.S. at
553; Howey, 328 U.S. at 298. Thus the 1933 and 1934 Securities Acts
do not apply to pension plans to which employees do not contribute
and in which employee participation is compulsory because such a
consideration in return for a separable financial interest with the
characteristics of a security.”
Daniel, 439 U.S. at 559, 570.
The SEC subsequently expanded Daniel beyond pension plans
to all involuntary and noncontributory employee benefit plans.
Release No. 33-6188 (Feb. 1, 1980); SEC Release No. 33-6281 (Jan.
Only an actual direct purchaser or seller of securities
has standing to sue under Section 10(b) and Rule 10b-5.
Stamps, 421 U.S. at 749-55, ratifying Birnbaum v. Newport Steel
Corp., 193 F.3d 461, 462-63 (2d Cir. 1952).
Section 11(a) of the
Securities Act of 1933 “gave a right of action by reason of a false
bargains for . . . stock, there is no ‘purchase or sale’ of
securities.”). They distinguish cases “in which an employee was
found to have purchased or sold stock options in return for labor”
as “based on the concept that the options are ‘a quid pro quo
offered to induce plaintiff to enter into the employ of
Id., citing as examples Yoder, 751 F.2d at 560;
Rudinger v. Insurance Data Processing, Inc., 778 F. Supp. 1334
(E.D. Pa. 1991); and Collins v. Rukin, 342 F. Supp. 1282 (D. Mass.
- 53 -
registration statement to ‘any person acquiring the security, and
§ 12 of the Act gave a right to sue the seller of a security who had
engaged in proscribed practices with respect to prospectuses and
communication to ‘the person purchasing such security from him.’”
Blue Chip Stamps, 421 U.S. at 728.
Section 2(3) of the Securities
Act of 1933 states, “The term ‘sale’ or ‘sell’ shall include every
contract of sale or disposition of a security or interest in a
security for value,” while section 3(a)(14) of the Securities
Exchange Act of 1934 provides, “The terms ‘sales’ and ‘sell’ each
include any contract to sell or otherwise dispose of.”
Arising in the wake of Daniel’s holding that an interest
in a compulsory, noncontributory pension plan is not a “security,”
the SEC’s “no-sale doctrine” provides that a grant of securities to
employees pursuant to a stock bonus plan is not a “purchase or sale”
where these employees “do not individually bargain to contribute
cash or other tangible or definable consideration to such plans.”
SEC Release No. 33-6188, 1980 WL 29482 at *1521 (Feb. 1, 1980).
Id. at *8.
Thus compulsory noncontributory stock option
plans where the employees do not individually bargain to contribute
cash or other consideration are not “sales” under the definition of
the Securities Act of 1933.
See also Compass Group PLC, SEC
Or 1980 SEC LEXIS 2141 at *15.
- 54 -
registration of stock options was not required “when an employee
continuation of employment nor independently bargains for such
stock, as a stock bonus program that involves the award of stock to
employees at no direct cause.”).
When an employee does not give
employment nor independently bargains for . . . stock, as when the
employee receives his stock through a company-wide stock option plan
“there is no ‘purchase or sale’ of securities.”
Wyatt v. Cendant
Corp. (In re Cendant Corp. Sec. Litig.), 81 F. Supp. 2d 550, 556
(D.N.J. 2000)(internal quotation omitted); McLaughlin v. Cendant
Corp., (In re Cendant Corp. Sec. Litig.), 76 F. Supp. 2d 539, 550
(D.N.J. 1999)(“Under the SEC’s ‘no sale’ doctrine, a grant of
securities to an employee pursuant to a stock bonus plan is not a
‘purchase’ or sale’ because these employees ‘do not individually
consideration to such plan . . . [and] employees in almost all
instances would decide to participate if given the opportunity.”),
citing Securities Release No. 33-6188, 1980 WL 29482, and Compass
The phrase “for
of 1933 has been construed
surrender of a legal right.
value” in § 2(1) of the Securities Act
to include a wide variety of forms of
property, cash, services, and the
SEC Release No. 33-6188, 1980 WL 29482,
- 55 -
1999)(finding that no registration of stock options was required
“when an employee does not give anything of value for stock other
than the continuation of employment no independently bargains for
such stock, such as a stock bonus program that involves the award
of stock to employees at no direct cost.”); Daniel, 439 U.S. at 55859 (holding that the Exchange Act does not apply to noncontributory,
noncontributory compulsory pension plan by definition makes no
payment into the pension fund.”).
This reasoning has been applied to employee stock option
Cendant, 76 F. Supp. 2d at 545-46, citing Bauman v. Bish,
571 F. Supp. 1054 (N.D.W. Va. 1983)(concluding that an employee
stock option plan was “compulsory” where “there [was] no affirmative
investment decision” made by the individual employee), and Childers
v. Northwest Airlines, Inc., 688 F. Supp. 1357, 1363, 1364 (D. Minn.
1988)(“Plaintiffs’ participation was an incident of employment and
their only choice would have been to forego the receipt of benefits
entirely”; “The notion that the exchange of labor will suffice to
constitute the type of investment which the Securities Acts were
intended to regulate was rejected in Daniel”).
Only “[w]here an
employee . . . acquires the right to [stock] options as part of his
or her bargained-for compensation [will courts] infer that the
employee made an intentional decision to ‘purchase’ the options.”
- 56 -
Cendant, 81 F. Supp. 2d at 557-58,23 citing Yoder v. Orthomolecular
Nutrition Inst., Inc., 751 F.2d 555, 560 (2d Cir. 1985)(noting that
the definitional sections of the two Acts, § 2 of the 1933 Act and
§ 2 of the 1934 Act, begin with the proviso, “When used in this
title, unless the context otherwise requires24 [emphasis added by
“To ‘purchase or sell’ stock options, employeepurchasers must give up a specific consideration in return for a
separable financial interest with the characteristics of a
security.” Cendant, 81 F. Supp. 2d at 556. In accord Fishoff v.
Coty, Inc., No. 09 Civ. 628 (SAS), 2009 WL 1585769, at *5 & n.74
(S.D.N.Y. June 8, 2009), citing Fraser v. Fiduciary Trust Co.,
Intern., 417 F. Supp. 310, 318 (S.D.N.Y. 2006).
Addressing this key phrase in the beginning of the
definitional sections of the 1933 and 1934 Acts, Matthew T. Bodie
explains in Aligning Incentives With Equity:
Options and Rule 10b-5, 88 Iowa L. Rev. 539, 558-59 (March 2003),
Courts and commentators have debated over the
exact meaning of this exception, particularly
whether “context” means “in the context of the
statute’s text,” or “in the context of the
facts of the case.” In two Rule 10b-5 cases
involving employee ownership interests-–one
involving stock [Yoder v. Orthomolecular
Nutrition Institute, Inc.], the other stock
options [Collins v. Rukin, 342 F. Supp. 1282,
1286 (D. Mass. 1972)(defendant corporation
offered plaintiff a stock option as an
satisfied the “for value” requirement of the
securities laws should not apply in the
“context” of securities that form a part of an
employment contract. In both cases, while the
courts noted that the securities laws were
nevertheless found the securities protections
broad enough to encompass employees with
interests in their companies.
Friendly wrote in the Yoder case, “We see no
- 57 -
this Court], . . . ,” and finding that the promise of a stock
distribution in exchange for an individually bargained employee
contract could be consideration for a “sale” under the Securities
Act); Childers v. Northwest Airlines, Inc., 688 F. Supp. 1357, 1363
(D. Minn. 1988)(“Plaintiffs’ participation was an incident of
employment and their only choice would have been to forgo the
receipt of benefits entirely.”).25
involuntary, the stock awarded to employees is not required to be
registered because there is no “sale” to the employees since they
consideration to the employee stock ownership plan.
Release No. 33-6188.
These courts and the SEC Release grew out of
finding that these stock option employees that did not
directly contribute to the plan failed to meet the “investment of
sale/purchase and the SEC’s “no-sale” doctrine.
Plaintiffs rely on decision by the Ninth Circuit in
reason why ‘the context requires’ us to hold
that an individual who commits herself to
employment by a corporation in return for
stock or the promise of stock should not be
considered an investor.”
As noted, under Howey and Daniel, an employee’s
participation in a noncontributory, compulsory pension plan also
cannot be characterized as an investment contract. Daniel, 439
U.S. at 559.
- 58 -
Falkowski v. Imation Corp., 309 F.3d 1123 (2002), amended, 320 F.3d
905 (9th Cir. 2003), that is contrary to the Cedant cases and to the
1980 SEC Release.
The panel in Falkowski, interpreting SLUSA and
its preemption of class actions that involved charges of fraud ”in
connection with the purchase and sale of a covered security,”
comprised of employees and contractors of Cemax who had received
stock options through a company plan from their original employer,
Cemax-Icon (“Cemax”), which was subsequently acquired by Imation and
their options were converted to Imation stock options. Id. at 112627.
A year later Imation sold Cemax to Eastman Kodak Company, and
in connection with that sale, according to the plaintiffs in their
class action, induced the employees to remain with Cemax-Imation
merged company by misrepresenting the value of their stock and
options and exaggerating the length of time they would have to
exercise their options.
Id. at 1127.
Instead of basing their
decision on the concept of an “investment contract” to which the
employees had failed to contribute anything in Daniel, the Ninth
Circuit panel observed that SLUSA’s language was very like that of
§ 10(b), which bars securities fraud “in connection with the
purchase or sale of any security.”
Id. at 1129.
emphasizing that the Supreme Court in SEC v. Zandford, 535 U.S. 813
(2002), found that § 10b “should be construed not technically and
restrictively, but flexibly to effectuate its remedial purposes” and
- 59 -
“be viewed as part of the remedial package of federal securities
laws,” the Ninth Circuit panel focused on the fact that “the 1933
and 1934 Acts define the purchase or sale of a security to include
any contract to buy or sell a security.”
Id. at 1129.
15 U.S.C. §§ 77b(a)(3).
They further reasoned that “if a
person contracts to sell a security, that contract is a ‘sale’ even
if the sale is never consummated.”
The panel determined, “The
grant of an employee stock option on a covered security is therefore
a ‘sale’ of the covered security.
The option is a contractual duty
to sell a security at a later date for a sum of money, should the
employee choose to buy it.
Whether or not the employee ever
exercises the option, it is a ‘sale’ under Congress’s definition.”
Id. at 1129-30.
They concluded, “Whether or not an option grant is
a sale in the lay sense, it is a sale under the securities laws
because it is a contract to sell a security when the option is
We reject the contrary holding of” the Cedant cases.
Id. at 1130.
This Court observes that Falkowski relied on a statement
in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 750-51
“A contract to purchase or sell securities is expressly
defined by section 3(a) of the 1934 Act, 15 U.S.C. section 78c(a),
as a purchase or sale of securities for the purposes of the Act. .
. . [T]he holders of
. . . options and other contractual rights or
duties to purchase or sell securities have been recognized as
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‘purchasers’ or ‘sellers’ of securities for purposes of Rule 10b-5,
not because of a judicial conclusion that they were similarly
situated to ‘purchasers’ or ‘sellers,’ but because the definitional
provisions of the 1934 Act themselves grant them such a status.”
In deciding to follow the Cedant cases and rejecting Falkowski, this
Court would emphasize that Blue Chip Stamps was issued before Daniel
(1979) and before the SEC 1980 Release.
Moreover in the 1980
Release, the SEC changed its prior position to accord with Daniel’s
and its progeny’s reasoning.
Additional reasons for not following
Falkowski are highlighted in McKissick v. Gemstar-TV Guide, Intern.,
Inc., 415 F. Supp. 2d 1240, 1244-45 (N.D. Okla. 2005).26
Congress, in enacting the Securities and
Exchange Act, provided definitions to help in
the interpretation and application of the
In Mckissick, as a result of the merger of TV Guide,
Inc. and Gemstar International Group Limited, in which TV Guide
became a wholly-owned subsidiary of Gemstar, each TV Guide
shareholder received a fractional share of Gemstar stock in
exchange for his TV Guide stock and each person who held stock
options for purchase of TV Guide stock were granted stock options
in Gemstar in the same fractional share given current shareholders.
The plaintiff, who was President and Chief Operating Officer of TV
Guide and had been awarded a number of stock options remained in
that position with the subsidiary after the merger in 2000, but
then left in 2003. She alleged that she had planned to exercise
her stock options with TV Guide before the merger, but was
fraudulently induced to hold them because of misrepresentations
that mere made to her during the merger on which she relied, so her
stock options were converted into Gemstar stock options.
after the value of Gemstar stock and her stock options
significantly decreased, causing her a major loss. She sued. The
plaintiff did not allege that she purchased or sold any stock at
the time of the merger, but only that she had a contractual right
to do so.
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See 15 U.S.C. 78c.
But, as the
Supreme Court has stated, “The relevant
definitional section of the 1934 Act are for
the most part unhelpful; they only declare
generally that the terms “purchase” and “sale”
shall include contracts to purchase or sell.
SEC v. Natl. Sec., Inc., 393 U.S. 453, 466 . .
. (1969). Thus, the Court must look to other
courts to discern boundaries for standing under
a Rule 10b-5 cause of action to determine if
the holding of stock options by the Plaintiff
constitutes a contract to purchase or sell
stocks. . . .
[T]he Supreme Court’s language in the Blue
Chip Stamps decision was nothing more than
dicta that alone cannot serve as the basis for
standing under 10(b) or Rule 10b-5. . . . To
allow the Plaintiff, who simply held her stock
options, to qualify as a purchaser or seller of
stock under Rule 10b-5 under these facts would
destroy the Supreme Court’s reasoning for
adopting the Birnbaum Rule.27
As the Court
stated, “In the absence of the Birnbaum
marketing process could await developments on
the sidelines without risk.” Blue Chip Stamps,
421 U.S. at 747. . . .Here, the Plaintiff is
exactly the person described by the Court, a
“bystander to the securities market.” Id.
Moreover, as the Fifth Circuit has noted, “It
is well established that the mere retention of
misrepresentations or omissions does not form
the basis for a section 10(b) or Rule 10b-5
Krim v. BancTexas Group, Inc., 989
F.2d 1435, 1443 n. 7 (5th Cir. 1993)(citing Blue
Chip Stamps, 421 U.S. 723 . . . .
Disregarding the Corporate Form
Plaintiffs contend that the three Defendant UBS entities
Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.
1952)(finding that a purchase or sale was required for a Rule 10b5 cause of action).
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(PW, Warburg, and nonparty UBS AG) form a single enterprise which
is liable to Plaintiffs for some or all of their alleged violations
of the Securities Exchange Act.
When an entity’s corporate form is
at issue, courts standardly hold that the law of the state of
incorporation of that entity applies to determine whether its
corporate form should be disregarded, i.e., whether one can pierce
the corporate veil.
Ace American Ins. Co. v. Huntsman Corp., 255
F.R.D. 179, 195 (S.D. Tex. 2008)(and cases cited therein).
Warburg were incorporated in Delaware; thus the Court applies
Delaware’s law to determine if their corporate forms should be
disregarded and UBS should be treated as a single enterprise
subsidiaries of UBS AG.
Contrary to Plaintiffs’ insistence that in
a Rule 12(b)(6) review the Court must accept their conclusory claim
that “UBS” is a single entity and not three separate corporations
as suggested by their names and corporate histories, under Delaware
law a corporate entity “may be disregarded ‘only in the interest of
justice, when such matters as fraud, contravention of law or
contract, public wrong, or equitable considerations among members
of the corporation require it, are involved.”
In re Phillips
As noted, the Third Circuit, which includes Delaware,
has rejected group pleading as failing to satisfy the PSLRA’s
particularity in pleading requirement. Winer, 503 F.3d at 335.
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Petroleum Sec. Litig., 738 F. Supp. 824, 838 (D. Del. 1990). A
conclusory statement that three entities are one is not sufficient
without specific facts supporting such an allegation.
corporate forms will not be disregarded “merely upon a showing of
corporation may be deemed the alter ego of its corporate parent29
where there is a lack of attention to corporate formalities, such
as where the assets of two entities are commingled and their
operations intertwined” or “where a corporate parent exercises
complete domination over its subsidiary.”
Mobil Oil Corp v. Linear
Films, Inc., 718 F. Supp. 260, 266 (D. Del. 1989).
To pierce the
corporate veil under an alter ego theory, Delaware law requires a
showing of fraud or similar injustice.
196 (and cases cited therein).
Ace American, 255 F.R.D. at
While the “general principle of
corporate law ‘deeply ingrained in our economic and legal systems”
is that “a parent corporation . . . is not liable for the acts of
its subsidiaries,” in exceptional circumstances plaintiffs may
allege and ultimately prove that an alter ego relationship exists,
in which a corporate parent exercises total domination and control
Delaware courts use varying terminology when addressing
the issue of liability in a parent-subsidiary relationship, “[y]et
regardless of the precise nomenclature employed, the contours of
the theory are the same.” Mobile Oil, 718 F. Supp. at 266. “Alter
ego” is often used interchangeably with “disregarding the corporate
entity,” “piercing the corporate veil,” “instrumentality,” and
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“operated as a single economic entity” so that “the corporation is
little more than a legal fiction,’” and the parent company has
Blair v. Infineon Technologies AG, 720 F. Supp.
462, 469 (D. Del. 2010), quoting United States v. Bestfoods, 524
U.S. 51, 61 (1998), and citing Bd. of Tr. of Teamsters Local 863
Pensions Fund v. Foodtown, Inc., 296 F.3d 164, 171 (3d Cir. 2002);
Pearson v. Component Tech. Corp, 247 F.3d 471, 485 (3d Cir. 2001);
and Mobil Oil Corp. v. Linear Films, Inc., 718 F. Supp. 260, 266 (D.
Del. 1989)(“A subsidiary corporation may be deemed the alter ego of
its corporate parent where there is a lack of attention to corporate
formalities, such as where the assets of two entities are commingled
and their operations intertwined.
An alter ego relationship might
also lie where a corporate parent exercises complete domination and
control over its subsidiary.”). As a tool of equity, under Delaware
law “[t]he corporate fiction may be disregarded to prevent fraud,”
and a wholly-owned subsidiary may sometimes be treated as an
instrumentality of the parent.
Buechner v. Farbenfabriken Bayer
38 Del. Ch. 490, 493 (Del. Ch. 1959).
The Third Circuit applies a “single entity test” that
considers seven factors in deciding generally whether two or more
corporation is grossly undercapitalized for the purposes of the
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formalities; (3) the non-payment of dividends; (4) the insolvency
of the debtor corporation at the time; (5) the siphoning of the
nonfunctioning of other officers or directors; (7) the absence of
corporate records; and (8) the fact that the corporation is merely
a facade for the operations of the dominant stockholder(s).
720 F. Supp. 2d at 470-71, citing United States v. Pisani, 646 F.2d
83, 88 (3d Cir. 1981)(approving the federal alter ego factors used
by the Fourth Circuit in DeWitt Truck Brokers, Inc. v. W. Ray
Fleming Fruit Co., 540 F.2d 681, 686-87 (4th Cir. 1976) to determine
whether it was appropriate to pierce the corporate veil).
no single factor justifies a decision to disregard the corporate
entity,” some combination of these factors is necessary and “an
overall element of injustice or unfairness must always be present
U.S. v. Golden Acres, Inc., 702 F. Supp. 1097, 1104 (D.
Del. 1988), aff’d sub nom. Golden Acres, Inc. v. Sutton Place Corp.,
879 F.2d 857 (3d Cir. 1989)(piercing the corporate veil where a
subsidiary was undercapitalized, corporate formalities were not
observed, the subsidiary was insolvent, the subsidiary did not pay
dividends, and defendants were siphoning funds from the subsidiary,
using it as “an incorporated pocketbook”).
Some of these seven
factors may be sufficient to show the requisite unfairness. Pisani,
646 F.2d at 88.
The test does not require evidence of actual fraud
as a prerequisite for piercing the corporate veil. Trustees of Nat.
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Elevator Industry Pension, Health Benefit and Educational Funds v.
Lutyk, 332 F.3d 88, 194 (3d Cir. 2003).
In a narrowed application of the alter ego theory, under
Delaware law a court may “pierce the corporate veil of a company
where . . .
it in fact is a mere instrumentality or alter ego of
its owner” and the two operate as a “single entity.”
Atex, Inc., 68 F.3d 1451, 1457 (2d Cir. 1995).
To prevail on an
alter ego claim, “a plaintiff must show (1) that the parent and the
subsidiary operated as a single economic entity and (2) that an
overall element of injustice or unfairness is present.”
the first element, the plaintiff must allege “exclusive domination
and control . . . to the point that [the subsidiary] no longer has
legal or independent significance of its own.”
Id., citing Wallace
ex rel. Cencom Cable Income Partners II, LP v. Wood, 752 A.2d 1175,
1183-84 (Del. Ch. 1999).
That element incorporates the list of
factors in the general corporate veil-piercing analysis:
corporate undertaking; whether the corporation was solvent; whether
dividends were paid, corporate records kept, officers and directors
functioned properly, and other corporate formalities were observed;
whether the dominant shareholder siphoned corporate funds; and
whether, in general, the corporation simply functioned as a facade
for the dominant shareholder.
In re Foxmeyer Corp., 290 B.R. 229,
235 (Bankr. D. Del. 2003), citing Harco National Ins. Co. v. Green
- 67 -
Farms, Inc., CIV. A. No. 1131, 1989 WL 110537, at *4 (Del. Ch. Sept.
19, 1989), quoting Golden Acres, 702 F. Supp. at 1104.
the second element the plaintiff must show fraud or injustice
inherent “in the defendant’s use of the corporate form”;
“[t]he underlying cause of action, at least by itself, does not
supply the necessary fraud or injustice,” but is distinct from the
tort alleged in the suit.
Id., citing In re Foxmeyer Corp., 290
B.R. 229, 236 (Bankr. D. Del. 2003); Sears, Roebuck & Co. v. Sears
plc, 744 F. Supp. 1297, 1305 (D. Del. 1990).
“‘To hold otherwise
would render the fraud or injustice element meaningless, and would
Id., citing Mobil Oil, 718 F. Supp. at
To pierce the corporate veil, the corporate structure must
cause the fraud, and the fraud or injustice must be found in the
defendants’ use of the corporate form; the corporation must be a
fraud or a sham existing only for the purpose of serving as a
vehicle for fraud.
Foxmeyer, 290 B.R. at 236 (cases not cited).30
In Skouras v. Admiralty Enterprises, Inc., 386 A.2d
674, 681 (Del. Ch. 1978), citing Buechner v. Farbenfabriken Bayer
Aktiengesellschaft, 154 A.2d 684 (Del. Supr. 1959), and State ex
rel. Rogers v. Sherman Oil Co., 117 A. 122 (Del. Supr. 1922), the
Delaware Court of Chancery emphasized that mere control and even
total ownership of one corporation by another is not sufficient to
warrant the disregard of a separate corporate entity under Delaware
law: [a]bsent a showing of a fraud or that a subsidiary is in fact
the mere alter ego of the parent, a common central management alone
is not a proper basis for disregarding separate corporate
existence.” In accord, eCommerce Industries, Inc. v. MWA
Intelligence, Inc., C.A. No. 7471-VCP, 2013 WL 5621678, at *27
(Del. Ch. Oct. 4, 2013). In Skouras, the court found that the
parent corporation’s “subsidiary corporations were so organized and
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Plaintiffs have failed to allege any of these kinds of
facts to warrant disregarding the corporate forms of PW and Warburg.
Stock Broker Standards
At issue in this case is whether PW, in its brokerage
relationship with the investor participants in the Enron Stock
decline to its investor retail clients purchasing or holding Enron
securities or debt.
Firms in the securities market operate in three main
capacities: broker, broker-dealer, and investment advisor. Thomas
controlled and their affairs are so conducted as to make them
adjuncts or instrumentalities of the defendant company,” and it
listed factors that might be considered in determining whether a
parent corporation is liable for the wrongdoing of a subsidiary
because they operated as a single economic unit, including whether
all of the subsidiary corporations were
engaged in the same general business as the
parent; the parent owned all of the shares .
. . of the subsidiaries; all the members of
the boards of directors of . . . the
subsidiary corporations were also directors of
defendant, and a majority of members of the
boards of the remaining . . . subsidiaries
were directors of defendant. Furthermore, the
books of the subsidiaries were not in
defendant’s possession, custody, or control.
Upon determining that the separate subsidiary
corporations had been formed for fraudulent
purposes, this court granted plaintiffs’
demand for inspection of the books of
defendant’s subsidiaries. . . .
Id. at 681.
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Lee Hazen, “Are Existing Stock Broker Standards Sufficient?,” 2010
Colum. Bus. L. Rev. 710, 730 (2010).
A “broker” is defined in Black’s Law Dictionary (6th ed.
West 1990) as, “An agent employed to make bargains and contracts for
A dealer in securities issued by others. . . . An
agent of a buyer or seller who buys or sells stocks, bonds,
commodities, or services, usually on a commission basis.”
Rauscher Pierce Refsnes, Inc. v. Great Southwest Sav., F.A., 923
relationship between a broker and its customer is that of principal
Under the Exchange Act, 15 U.S.C. § 78c(a)(4)(A), a
transactions in securities for the account of others.”
A “broker-dealer” is defined as a “securities brokerage
firm, usually registered with the S.E.C. and with the state in which
it does business, engaging in the business of buying and selling
securities to or for customers.”
Black’s Law Dictionary (6th ed.
There is no explicit fiduciary standard applicable to
Under the Exchange Act a “dealer” is a person who
engages in “the business of buying and selling securities . . . for
such person’s own account,” and not as part of a regular business.
15 U.S.C. § 78c(a)(5)(A). The term broker-dealer includes persons
who act as brokers, dealers, or both brokers and dealers. Tuch,
Self-Regulation, 83 Geo. Wash. L. Rev. at 117. In the context of
securities offerings, an investment banker plays two roles: it
counsels the corporate issuer and, if it underwrites the offering
on a firm-commitment basis, commits to acquiring the issuer’s
securities, and it sells those securities to investors. Id. at
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broker-dealers under the Exchange Act,32 but when they do more than
act as order takers for their clients’ transactions, they must meet
other standards, including of suitability in making investment
recommendations to their clients, and they must satisfy the rules
of the self-regulatory organizations (“SROs”), including national
securities exchanges and the Financial Industry Regulatory Authority
(“FINRA,” the self-regulatory body for broker-dealers) that oversee
Thomas Lee Hazen, “Fiduciary Obligations of Securities
Brokers,” 5 Law Sec. Reg. § 14:133 (March 2016 update).
Thus while a broker owes his investor-client a fiduciary
relationship, and determining that nature requires a fact-based
analysis. Romano v. Merrill Lynch, Pierce, Fenner & Smith, 834 F.2d
523, 520 (5th Cir. 1987), cert. denied,487 U.S. 1205 (1988).
nature of the account, whether nondiscretionary or discretionary,
is one factor to be considered, as are the degree of trust placed
in the broker and the intelligence and qualities of the customer.
Investment banks are correctly designated as brokerdealers, as evidenced by FINRA rules and the SEC’s Guide to BrokerDealer Registration. Id. at 118. In particular they qualify as
brokers where they advise on security offerings, are involved in
the sale or exchange of securities and receive fees for that
service, negotiate between the issuer and the investor, and counsel
on structuring transactions. Id. at 118-20.
Section 913(g) of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010, Pub. L. No. 111-203, 124 Stat. at
1827-28, gives the SEC rulemaking authority to impose a fiduciary
duty on broker-dealers, but it has not done so.
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A broker’s duty
is usually restricted to executing the
investor’s order when “the investor controls a nondiscretionary
account and retains the ability to make investment decisions.”33
Romano, 834 F.2d at 530; Martinez Tapia v. Chase Manhattan Bank,
N.A., 149 F.3d 404, 412 (5th Cir. 1998).
When investors “lack the time, capacity, or know-how to
supervise investment decisions” and “delegate authority to a broker
who will make decisions in their best interests without prior
approval” in a discretionary account, however, there well may be a
duty to disclose. Town North Bank, N.A. v. Shay Financial Services,
Inc., Civ. A. No. 3:11-CV-3125-L, 2014 WL 4851558, at *17 (N.D. Tex.
Sept. 30, 2014), citing Martinez Tapia, 149 F.3d at 412,34 and
v. Zandford, 535 U.S. 813, 823 (2002).
Under Texas law,
In a non-discretionary account, the agency
relationship begins when the customer places
the order and ends when the broker executes it
because the broker’s duties in this type of
On the other hand, where the broker’s duty simply
consists of bringing parties together so they can negotiate a sale
by themselves, he is merely a middleman and not necessarily an
“agent” of any.
Rauscher, 923 S.W. 2d at 115.
whether an agency relationship exists is usually a question of
fact. Coleman v. Klockner & Co., 180 S.W. 3d 577, 587 (Tex. App.–Houston [14th Dist.] 2005)
Citing Hill v. Bache Halsey Stuart Shields, Inc., 790
F.2d 817, 825 (11th Cir. 1996)(“fiduciary duty in the context of
brokerage relationship is only an added degree of responsibility
to carry out pre-existing, agreed-upon tasks properly”); Limbaugh
v. Merrill Lynch Pierce, Fenner & Smith, 732 F.2d 859, 862 (11th
Cir. 1984)(“duty owed by the broker was simply to execute the
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account, unlike those of an investment advisor
or those of a manager of a discretionary
account, are “only to fulfill the mechanical,
ministerial requirements of the purchase or
sale of the security . . . .” As a general
proposition, a broker’s duty in relation to a
nondiscretionary account is complete, and his
authority ceases, when the sale or purchase is
made and the receipts therefrom accounted for.
Thus, each new order is a new request that the
proposed agent consents to act for the
There is no on-going agency
relationship as there would be with a financial
advisor or manager of a discretionary account.
Hand v. Dean Witter Reynolds, Inc., 889 S.W. 2d 483, 493-94 (Tex.
App.--Houston [14th Dist.] 1994, writ denied)(citations omitted).
In a discretionary investment account, in contrast to a
nondiscretionary account, a broker is a “fiduciary of his customer
in a broad sense” and is required to
(1) manage the account in a manner directly
comporting with the needs and objectives of the
customer as stated in the authorization papers
or as apparent from the customer’s investment
regarding the changes in the market which
responsively to protect these interests; (3)
keep his customer informed as to each completed
transaction; and (4) explain forthrightly the
practical impact and potential risks of the
course of dealing in which the broker is
Anton v. Merrill Lynch, 36 S.W. 3d 251, 257-58 (Tex. App.--Austin
2001, rev. denied)(citations omitted, emphases added in Anton),
quoting Leib v. Merrill Lynch, Fenner & Smith, Inc., 461 F. Supp.
- 73 -
951, 953 (E.D. Mich. 1978), aff’d, 647 F.2d 165 (6th Cir. 1981).35
Although there is no statutorily mandated heightened
pleading of fiduciary duty for brokers, Thomas Lee Hazen, a noted
scholar in the field, points out that “there is plenty of authority
under the existing law that recognizes heightened obligations of
securities broker-dealers, at least when they are acting in a
regulations, and regulatory interpretations to date make clear that
broker-dealers have fiduciary or fiduciary-like obligations when
they provide services beyond executing customer orders.”
“Are Existing Stock Broker Standards Sufficient?,” 2010 Colum. Bus.
L. Rev. 710, 713-14 (2010).
These legal sources include the
Investment Advisers Act of 1940, regarding which the Supreme Court
has held that, even though the word “fiduciary” does not appear in
the statute, investment advisers are fiduciaries to their clients
and must meet the fiduciary duties of care and loyalty, i.e., they
investments . . . [and] all conflicts of interests when giving
Also cited by other courts in the Fifth Circuit, e.g.,
In re Rea, 245 B.R. 77, 88, 89-90 (N.D. Tex. 2000); Puckett v.
Rufenacht, Bromagen & Hertz, Civ. App. No. H-88-0035(W), 1989 WL
265340, at *5 (S.D. Miss. May 31, 1989), aff’d in part by 903 F.2d
1014 (5th Cir. 1990), amended by 919 F.2d 992 (1990), certified
question (“What duty of care under Mississippi law does a
nondiscretionary account?”), answered by 587 So. 2d 273 (Miss.
- 74 -
Id. at 716, citing SEC v. Capital Gains Research Bureau,
375 U.S. 180, 191-92 (1963).
A fundamental purpose common to a
number of statutes enacted in the 1930's, including the Investment
Advisers Act and the 1934 Act, “was to substitute a philosophy of
full disclosure for the philosophy of caveat emptor and thus to
achieve a high standard of business ethics in the securities
SEC v. Capital Gains Research Bureau, 375 U.S. at 186.
The Investment Advisers Act of 1940, 15 U.S.C. § 80b-
2(a)(11), however, defines “investment adviser” in relevant part as
“Investment adviser” means any person who, for
compensation, engages in the business of
advising others, either directly or through
publications or writings, as to the value of
securities or as to the advisability of
securities, or who, for compensation and as
part of a regular business, issues or
promulgates analyses or reports concerning
securities, but does not include . . . (C) any
broker or dealer whose performances of such
services is solely incidental to the conduct of
his business as a broker or dealer and who
receives no special compensation therefor . .
The Court concludes from the allegations in the complaint and the
lack of mention of any special compensation for PW’s advice to its
retail clients that PW does not qualify as an investment advisor
under subsection (C).
See, e.g., Banca Cremi, S.A. v. Alex. Brown
& Sons, Inc., 132 F.3d 1017, 1039 (4th Cir. 1997)(“In this case, it
is clear that, to the extent that Epley and Alex. Brown provided
- 75 -
incidental to the conduct of business as a broker dealer’” and “the
Bank was not an ‘advisory client’ of the defendants.”).
complaint states that PW did not charge Enron any fee to administer
the Employee Stock Option program, and charged the employees merely
six cents per share to exercise their options, apparently an
administrative charge for effecting the transaction.
#122 ¶ 67.
Furthermore the Supreme Court has held that private rights
of action under the Investment Advisers Act of 1940 are restricted
to suits for equitable relief for rescission of investment adviser
Transamerica Mortg. Advisors, Inc. v. Lewis, 444 U.S.
“‘[T]he rescinding party may have restitution of the
consideration given under the contract, less any value conferred by
the other party.’”
Douglass v. Beakley, 900 F. Supp. 2d 736, 745
(N.D. Tex. 2012), citing Transamerica Mortg. Advisors, 444 U.S. at
The SEC may enforce the Act by obtaining an injunction
mandating that a registered investment adviser disclose to his
clients any of the adviser’s violations of his duties under the Act.
Capital Gains, 375 U.S. at 181.36
As the Fifth Circuit observed in Laird v. Integrated
Resources, Inc., 897 F.2d 826, 833-37 (5th Cir. 1990), “Other
circuits understand the investment adviser’s fiduciary status to
require disclosure of any conflicts of interest for the purpose of
assessing liability under rule 10(b)-5.”
Id., citing and
discussing SEC v. Blavin, 760 F.3d 706, 711-12 (6th Cir. 1985)(“As
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Relevant to the determination whether broker-dealers have
fiduciary or fiduciary-like obligations when they provide services
beyond executing customer orders are SEC rules, particularly those
addressing “(a) conflicts between the firm’s obligations to its
customers and its own financial interests, and (b) trading in or
recommending securities in the absence of adequate information about
the issuer,” made pursuant to the general anti-fraud provisions of
sections 10(b), 15 U.S.C. § 78j(b), and 15(c), 15 U.S.C. §78o(c),
of the 1934 Act, section 17(a) of the Securities Act of 1933, 15
a fiduciary, the standard of care to which an investment adviser
must adhere imposes ‘an affirmative duty of ‘utmost good faith, and
full and fair disclosure to all material facts,’ as well as an
affirmative obligation to ‘employ reasonable care to avoid
misleading’ his clients.”)(citing Capital Gains), and Zweig v.
Hearst Corp., 594 F.2d 1261, 1267-68 (9th Cir. 1979)(addressing
section 206(1) and (2)(“It shall be unlawful for any investment
adviser, by use of the mails and any means or instrumentality of
interstate commerce, directly or indirectly (1) to employ any
device, scheme, or artifice to defraud any client or prospective
client; (2) to engage in any transaction, practice, or course of
business which operates as a fraud or deceit upon any client or
prospective client . . . .”), which tracks the language in Rule
10b-5, of the Investment Advisers Act, as amended 15 U.S.C. § 80b6(1,2), as analogous to § 10(b) and Rule 10b-5 of the Securities
Exchange Act)(“The plaintiffs here do not argue that Campbell was
an investment adviser as defined in the statute; thus Capital Gains
is not controlling. But the failure to bring the case within the
Investment Advisers Act does not mean that the claim under Section
10(b) and Rule 10b-5 should fail. We hold that as applied to the
facts we must assume in this case, the Investment Advisers Act was
not meant to limit the Securities Exchange Act or Rule 10b-5.
Instead, we believe these provisions complement each other and
provide different means to curb slightly different types of ‘fraud
or deceit.’ . . . A number of cases since Capital Gains suggest
that Rule 10b-5 requires the disclosure of conflicts of interests
in situations similar to the facts of this case.”).
- 77 -
U.S.C. § 77q(a),37 and section 206 of the Investment Advisers Act,
Hazen, “Are Existing Stock Broker Standards
Sufficient?,” 2010 Colum. Bus. L. Rev. at 722.
In the late 1930's, Congress amended the Exchange Act to
authorize self-regulatory organizations for broker dealers.
e.g., Andrew F. Tuch, The Self-Regulation of Investment Bankers, 83
Securities Exchange Act of 1934, Pub. L. No. 73-291, 48 Stat. 8881
(codified as amended at 15 U.S.C. §§ 78a-78pp (2012)).
Section 77q(a), addressing “Use of interstate commerce
for purpose of fraud or deceit, states,
It shall be unlawful for any person in the
offer or sale of any securities (including
security-based swaps) or any security-based
78c(a)(78) of this title) or by use of any
means or instruments of transportation or
communication in interstate commerce or by use
of the mails, directly or indirectly
(1) to employ any device, scheme, or
artifice to defraud, or
(2) to obtain money or property by means
of any untrue statement of a material
fact or any omission to state a material
fact necessary in order to make the
circumstances under which they were made,
not misleading; or
(3) to engage in any transaction,
practice, or course of business which
operates or would operate as a fraud or
deceit upon the purchaser.
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particularly highlights the SEC and FINRA [formed in 2007 to replace
regulations38 as sources of fiduciary-like duties.
Id. at 733-55.
Sections 6(b)(5) and 15A(b)(6) of the Securities Exchange Act
require stock exchanges and associations of brokers and securities
dealers to establish rules to protect the investing public from
fraudulent and manipulative practices in the securities market.
U.S.C. § 78o-3(b)(6).
In response, a number of national exchanges
and SROs have adopted “suitability rules” for brokers.
adopted Rule 2310(a), which provides,
In recommending to a customer the purchase,
sale or exchange of any security, a member
shall have reasonable grounds for believing
that the recommendation is suitable for such
customer upon the basis of the facts, if any,
disclosed by such customer as to his other
security holdings and as to his financial
situation and needs.” This is the so-called
“suitability rule,” and its purpose is to
protect unsophisticated investors of publiclyheld corporations from the sometimes devious
The NYSE adopted a similar, “know your customer rule,” NYSE Rule
405(a), which requires the officers of member organizations to “use
diligence to learn essential facts relative to every customer, every
order, every cash or margin account accepted or carried by such
For example, Article III, NSAD Rules of Fair Practice,
NASD Manual (CCH) ¶ 2151 provides, “A member, in the conduct of his
business, shall observe high standards of commercial honor and just
and equitable principles of trade.”
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organization.” Generally regulatory rules of conduct do not provide
a private right of action for individual investors, but are for
actions brought by the SEC or state regulatory investors.
result, aggrieved individual investors must frame their securities
complaints as claims under § 10(b) of the Exchange Act and Rule 10b5. Steven D. Irwin, Scott A. Lane, and Carolyn W. Mendelson, Wasn’t
My Brother Always Looking Out For My Best Interests?
The Road to
independent claim for economic relief in a civil proceeding for the
investor who suffered a loss at the hands of a broker who has made
an unsuitable trade recommendation. Instead, the aggrieved investor
must state a valid claim under Rule 10b-5.
The plaintiff must
allege, in connection with the purchase or sale of securities, the
misstatement or omission of a material fact, made with scienter,
upon which the plaintiff justifiably relied and which proximately
caused the plaintiff’s injury.”).
Hazen comments regarding violations of NYSE, FINRA or NASD
rules that “it is generally held that violation of a rule or a self
regulatory organization will not, by itself, support a private right
However, a violation of an exchange or FINRA rule can
form the basis of a 10b-5 action, provided of course, that all of
the elements of a 10b-5 claim can be established.”
Broker-Dealer Regulation; Credit Rating agencies,” 5
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Law Sec. Reg. § 14:175 (updated March 2016).
The courts are split
in a variety of ways over whether a private right of action exists
for violations of such rules and regulations.
The Fifth Circuit has deliberately chosen not to decide
whether rules for brokers established by national exchanges and
SROs, such as the NASD suitability rule or the NYSE “know your
customer rule,” provide a private cause of action for individual
investors, but has found that they may be used as evidence of
industry standards and practices. Miley v. Oppenheimer & Co., Inc.,
637 F.2d 318, 333 (5th Cir. 1981)(en banc)(in a churning case “NYSE
and NASD rules are excellent tools against which to assess in part
the reasonableness or excessiveness of a broker’s handling of an
investor’s account,” the other five factors being the nature and
objectives of the account, the turnover rate, in-and-out trading,
the holding period of the respective securities, and the broker’s
profit), abrogated on other grounds, 470 U.S. 213 (1985).
The Securities Exchange Act has no express civil remedy
for a violation of an exchange or association rule.
In a seminal
opinion in Colonial Realty v. Bache and Co., 358 F.2d 178, 181 (2d
Cir. 1965), cert. denied, 385 U.S. 817 (1966), in which a client
sued his broker-dealer for failure to conduct its dealings in
accordance with just and equitable principles of trade in violation
of NYSE and NASD rules, Judge Henry J. Friendly opined that since
a private remedy is not expressly stated in the 1934 Act, the
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finding of an implied private cause of action should be based on the
court’s duty to effect Congress’s purpose in the statute and the
federal policy it has adopted.
A court may find an implied right
of action under the Securities Exchange Act where there is explicit
condemnation of certain conduct in the statute and when the statute
provides a general grant of jurisdiction to enforce liability. Id.
Judge Friendly concluded that there could be no general rule as to
when a private claim can be maintained for a violation of NYSE and
NASD rules because “the effect and significance of particular rules
may vary with the manner of their adoption and their relationship
to provisions and purpose of the statute and SEC regulations
An implied action may arise from the protection
intended by the legislature and the ineffectiveness of existing
administrative and judicial remedies to accomplish.
The court must
examine the nature of the specific rule and its role in the
regulatory scheme, with the party seeking to impose liability
bearing a heavier burden of persuasion than the violation of the
statute or of an SEC regulation would require.
Id. at 182.
Friendly concluded, “The case for implication of liability would be
strongest when the rule imposes an explicit duty unknown to the
Id. Judge Friendly found that a private cause of
action may exist under section 6 of the 1934 Act, which requires a
securities association like the NASD to adopt disciplinary rules.
Id. 181-83. He found an implied cause of action where the rule that
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was violated either constituted a substitute for an SEC regulation
and where the rule that was violated established an explicit duty
unknown to the common law.
Id. at 182.
As indicated in Miley, the Fifth Circuit has been hesitant
to recognize a private cause of action based only on a violation of
a NYSE or NASD rule.
See also Porter v. Shearson Lehman Bros.,
Inc., 802 F. Supp. 41, 61 (S.D. Tex. 1992), in which the Honorable
Ewing Werlein, noting Judge Friendly’s opinion, emphasized that the
1934 Act “did not specifically authorize actions for violation of
private associations rules,” including the “suitability” rule of
NASD, which “requires generally that a broker recommend a purchase
or sale only after determining that the recommendation is suitable
to the customer, and that he use due diligence to learn essential
facts regarding the customer. . . . Congress could not have meant
that NASD should be given the authority to define new crimes.”
Observing that district courts within the Fifth Circuit were split
about whether an implied cause of action may be based on the NASD
or stock exchange rules, Judge Werlein observed that in Miley and
in Jolley v. Welch, 904 F.2d 988, 993 (5th Cir. 1990), cert. denied,
498 U.S. 1050 (1981), the Fifth Circuit permitted the NYSE and NASD
rules to be considered as one of six factors in determining an
element of an excessive trading violation (churning), but not as a
private cause of action.
Porter, 802 F. Supp. at 62-63.
Lange v. H. Hentz & Co., 418 F. Supp. 1376 (N.D. Tex. 1976)(NASD
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rules are evidence of the standard of care NASD members should
fiduciary duties are owed by a broker to his investor).
In 1988 Congress passed Section 15(f) of the Exchange Act,
15 U.S.C. § 78o(f),39 and Section 204A of the Investment Advisers
Section 78o(f) provides,
Every registered broker or dealer shall make
appropriate rules or regulations about these
policies and procedures.
See 17 C.F.R. §§
230.37, 230.138, 230.139. Thus an investment
bank is required to erect a Chinese wall
between its securities analysts’ research
commercial banking, underwriting, or other
services to issuers of securities to prevent
information from the latter influencing the
Section 204A of the Investment Advisers Act, 15 U.S.C.
(“Prevention of misuse of nonpublic information”)
Every investment adviser subject to section
80b-4 of this title shall establish, maintain,
and enforce written policies and procedures
reasonably designed, taking into consideration
the nature of such investment adviser’s
business, to prevent the misuse in violation
of this chapter of the Securities Exchange Act
of 1934 [15 U.S.C.A. § 78a et seq.], or the
rules and regulations thereunder, of material
nonpublic information by such investment
The Commission, as it deems
necessary or appropriate in the public
interest or for the protection of investors,
shall adopt rules or regulations to require
specific policies or procedures reasonably
designed to prevent misuse in violation of
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investment advisers to establish, maintain, and enforce written
policies and procedures reasonably designed to preclude unlawful use
of material nonpublic information.
Federal common law has also imposed fiduciary duties in
relationship is a principal/agent relationship, some courts have
found fiduciary duties that generally accompany such a relationship,
including that “the broker must act in the customer’s best interests
and must refrain from self-dealing unless the customer consents
after full disclosure.” Hazen, “Are Existing Stock Broker Standards
Sufficient?,” 2010 Colum. Bus. L. Rev. at 736-37 & n.127.
broker recommends securities or transactions, heightened duties have
been found to apply that parallel those under the Investment
Advisers Act that arose from judicial interpretation.
Id. at 738.
Under the “shingle theory“ of the common law, “by hanging
up a shingle, a broker implicitly represents that he or she will
conduct business in an equitable and professional manner.” Id. at
749, 738-39. As an extension of the common law doctrine of “holding
out,” it has been long and well established that “a securities
broker occupies a special position of trust and confidence with
regard to his or her customer when making a recommendation, and that
this chapter or the Securities Exchange Act of
1934 [15 U.S.C.A. § 78a et seq.] (or the rules
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any recommendation of a security carries with it an implicit
representation that the broker has an adequate basis for the
Id. at 750-51, citing Hanly v. SEC, 415 F.2d 589,
506 (2d Cir. 1969).
As another basis for enforcing suitability, the “shingle
theory” holds that the SEC and self-regulatory rules require brokerdealers to adhere to standards of fair and equitable principles of
trade and that breach of the implied representation that a broker
will deal fairly with the public [even at arm’s length] will be
actionable in a private action under the securities laws only if a
plaintiff customer can show a causal relationship between the
alleged breach and injury to the plaintiff; a breach of fiduciary
duty, alone, does not violate federal securities laws.
Id. at 750,
citing Charles Hughes & Co. v. SEC, 139 F.2d 434 (2d Cir. 1943),
cert. denied, 321 U.S. 786 (1944). Nevertheless, the Court has been
unable to find a single Texas case, no less a case in the Fifth
Circuit, that applies the shingle theory, so presumably it has not
been adopted in Texas.
“[A]ccountability for the implied representations that may
arise out of a fiduciary duty will not violate the securities laws’
antifraud provisions in the absence of showing that the defendant
acted with the requisite scienter.”
Thomas Lee Hazen, “Fiduciary
Obligations of Securities Brokers,” 5 Law Sec. Reg. § 14:133
(updated March 2016), citing In the Matter of Michael Flanagan,
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Ronald Kindschi, and Spectrum Administration, Inc., Release No. 160,
Release No. ID-160, 71 SEC Docket 1415, 2000 WL 98210, *24 (S.E.C.
Release No. 2000).
The SEC also directs attention to the “basic
principle” that by holding itself out as a broker-dealer, “a firm
is representing that it will act in the customer’s best interests.”
Id. & n.57 (and cases cited therein).
In addition, “[e]ven in the context of federal claims
against a broker-dealer, the federal courts may look to state law
to determine whether a fiduciary duty existed.”
Existing Stock Broker Standards Sufficient?,” 2010 Colum. Bus. L.
Rev. at 740, citing Press v. Chem. Inv. Servs. Corp., 166 F.3d 529,
536 (2d Cir. 1999)(finding no fiduciary duty under New York common
law for 10b-5 claims relating to mark-ups); SEC v. Pasternak, 561
F. Supp. 2d 459, 499 (D.N.J. 2008)(“To determine the existence of
a fiduciary relationship in federal securities fraud actions,
district courts generally look to state law.”).
that the “apparent majority of cases applying state common law”
found that although “there is no blanket fiduciary relationship
between a broker-dealer and a client as a matter of law,” certain
circumstances “can suffice to create a fiduciary duty,” especially
when the broker holds itself out as having investment expertise and
the customer places faith, confidence, and trust in the broker. Id.
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at 741-46. Even where there is no discretionary account, the degree
to which the broker cultivates a degree of trust and confidence in
the customer affects the obligations that the broker has to the
Id. at 748.
Among the duties that may be owed by a
broker to a customer in a non-discretionary account41 are “the duty
to recommend a stock only after studying it, sufficiently to become
informed as to its nature, price and financial prognosis,” “the duty
to inform the customer of the risks involved in purchasing or
selling a particular security,” “the duty to refrain from selfdealing or refusing to disclose any personal interest the broker may
have in a particular recommended security,” and “the duty not to
misrepresent any fact material to the transaction.”
Id. at 748-49,
citing Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 F.
Supp. 951, 953 (E.D. Mich. 1978)(and cases cited therein).
‘fiduciary’ is derived from the civil law and contemplates fair
dealing and good faith, rather than legal obligation, as the basis
of the transaction.
Further, that term includes those informal
A nondiscretionary account is one in which the customer
must approve all transactions before they are effected. Hand v.
Dean Witter Reynolds, Inc., 889 S.W. 2d 483, 492 (Tex. App.-Houston [14th Dist.] 1994, writ denied). A discretionary account
is one in which the broker makes the investment decisions and
manages the account. Id.
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relations which exist whenever one party trusts and relies upon
another, as well as technical fiduciary relations.”
Texas Bank and
Trust Co. v. Moore, 595 S.W. 2d 502, 507 (1980), citing Kinzbach
Tool, Inc. v. Corbett-Wallace Corp., 138 Tex. 565, 160 S.W. 2d 509
(1942). The Supreme Court in Texas Bank quoted the Illinois Supreme
Court in Higgins v. Chicago Title & Trust Co., 312 Ill. 11, 18, 143
N.E. 482, 484 (1924),
A fiduciary relation is not limited to cases of
trustee and cestui que trust, guardian and
ward, attorney and client, nor other recognized
legal relations, but it exists in all cases in
which influence has been acquired and abused,
in which confidence has been reposed and
betrayed, and the origin of the confidence is
immaterial, and may be moral, social, or
domestic or merely personal.
Moreover, “a fiduciary relationship exists when the parties are
‘under a duty to act for or give advice for the benefit of another
upon matters within the scope of the relation.’
It exists where a
special confidence is reposed in another who in equity and good
conscience is bound to act in good faith and with due regard to the
interests of the one reposing confidence.’”
Barker, 375 S.W. 2d 248, 251 (Ky. 1964).
Id., quoting Lappas v.
“The problem is one of
equity and the circumstances out of which a fiduciary relationship
will be said to arise are not subject to hard and fast lines.”
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In Texas, to state a claim for breach of fiduciary duty,
the plaintiff must plead “(1) a fiduciary relationship between the
plaintiff and defendants; (2) the defendant must have breached his
fiduciary duty to the plaintiff; and (3) the defendant’s breach must
result in injury to the plaintiff or benefit to the defendant.”
Billiteri v. Securities America, Inc., No. 09-CV-1568-F, 2010 WL
6785484, *9 (N.D. Tex. July 26, 2010), citing Jones v. Blume, 196
S.W. 3d 440, 447 (Tex. App.–-Dallas 2006, pet. denied).
recognizes two types of fiduciary duty, a formal relationship
arising as a matter of law, and an informal relationship, where
there is a close personal relationship of trust and confidence.
Navigant Consulting, Inc. v. Wilkinson, 508 F.3d 277, 283 (5th Cir.
2007); Willis v. Donnelly, 199 S.W. 3d 262, 277 (Tex. 2006).
latter arises from a “moral, social, domestic, or purely personal
relationship of trust and confidence.”
Meyer v. Cathey, 167 S.W.
3d 327, 331 (Tex. 2005); Thigpen v. Locke, 363 S.W. 2d 247, 253
“The existence of the fiduciary relationship is to be
determined from the actualities of the relationship between the
Thigpen, 363 S.W. 2d at 253.
Under Texas law the formal relationship between a broker
and its customer is one of principal and agent.
Refsnes, Inc. v. Great Southwest Savings, F.A., 923 S.W. 2d 112, 115
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(Tex. App.--Houston [14th Dist.] 1996), citing Magnum Corp. v.
Lehman Bros. Kuhn Loeb, Inc., 794 F.2d 198, 200 (5th Cir. 1986)(“The
relationship between a securities broker and its customer is that
of principal and agent. . . . . The law imposes upon the broker a
duty to disclose to the customer information that is material and
relevant to the order.”).
The relationship between an agent and a
principal is a fiduciary relationship under Texas law.
Touchstone, 620 S.W. 2d 687, 690 (Tex. App.--Dallas 1981), citing
Restatement (Second) of Agency § 1 (1958).
fiduciary relationship is a narrow one, starting with and restricted
to the scope of the agency. Hand v. Dean Witter Reynolds, Inc., 889
As with federal law, under Texas law “[i]n a non-
discretionary account, the agency relationship begins when the
customer places the order and ends when the broker executes it,
because the broker’s duties in this type of account, unlike those
of an investment advisor or those of a manager of a discretionary
requirements of the purchase or sale of the security or future[s]
contracts on the market.
As a general proposition, a broker’s duty
in relation to a nondiscretionary account is complete and his
authority ceases, when the sale or purchase is made and the receipts
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therefrom accounted for.”
Id. 493-94, citing Robinson v. Merrill
Lynch, Pierce, Fenner & Smith, Inc., 337 F. Supp. 107, 111 (N.D.
Ala. 1971), aff’d, 453 F.2d 417 (5th Cir. 1972).
In Rauscher, 923
S.W. 2d at 115 (citations omitted), the Fourteenth Court of Appeals
An agent is one who consents to act on behalf
of, and subject to, the control of another, the
principal, who has manifested consent that the
agent shall so act.
Agency is a consensual
relationship, and the agency or broker/customer
relationship does not come into existence until
the order has been placed and the broker has
consented to execute it. . . . If a broker,
under his contract with his principal, is
charged with no responsibility and is not
obligated to exercise any discretion, but his
duty consists of merely bringing the parties
together so that between themselves, they may
negotiate a sale, and the sale is made in that
manner, the broker is considered a mere
“middleman” and is not necessarily the “agent”
of either party.
The Restatement (Third) of Agency § 1.01 (2006) defines “agency” as
follows: “Agency is the fiduciary relationship that arises when one
person (a ‘principal’) manifests assent to another person (an
‘agent’) that the agent shall act on the principal’s behalf and
subject to the principal’s control, and the agent manifests assent
or otherwise consents so to act.”
An innate duty of good faith and
fair dealing, honest performance, and strict accountability is owed
by an agent to his principal, and is required in every transaction
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on behalf of the principal.
Vogt v. Wamock, 107 S.W. 3d 778, 782
(Tex. App.--El Paso 2003, pet. denied), citing Sassen v. Tanglegrove
Townhouse Condominium Ass’n, 877 S.W. 2d 489, 492 (Tex. App.-Texarkana 2001, pet. denied).
Nevertheless, under Texas law, to impose an informal
fiduciary duty in a business transaction, “the special relationship
of trust and confidence must exist prior to and apart from the
agreement that formed the basis of the suit.”
F. Supp. 3d
Aubrey v. Barlin,
, No. 1:10-CV-00076-DAE, 2016 WL 393551, at *7
(W.D. Tex. Feb. 1, 2016), citing Meyer v. Cathey, 167 S.W. 3d 327,
331 (Tex. 1998).
“[T]he fact that a business relationship has been
cordial and of extended duration is not by itself evidence of a
Floyd v. CIBC World Market, Inc., 426
B.R. 622, 651 (S.D. Tex. 2009), quoting Lexington Ins. Co. v. North
Am. Interpipe, Inc., Civ. A. No. H-08-3589, 2009 WL 1750523, at *3
(S.D. Tex. June 19, 2009).
Whether a fiduciary duty exists is a
question of law for the court.
Fuqua v. Taylor, 683 S.W. 2d 735,
737 (Tex. App.--Dallas 1984, writ ref’d n.r.e.).
The facts giving
rise to a fiduciary duty, however, are to be determined by the fact
Id. at 737-38.
Texas courts do not create a fiduciary
relationship lightly. Schlumberger Tech. Corp. v. Swanson, 959 S.W.
171, 177 (Tex. 1997); Meyer, 167 S.W. 3d at 331.
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Allegations of the Third Amended Complaint (#122)
Each of the eight named Lead Plaintiffs purchased or held
Enron equity securities and/or acquired stock options to purchase
Enron securities in his [or her] PW account “in reliance on the
information provided to him [or her] and absence of information
withheld from him” by PW during the Class Period.
#122, ¶¶ 5-12.
Plaintiffs contend that UBS owed them a duty of disclosure but
failed to disclose material information within its knowledge, gained
characterization of Enron’s financial condition throughout the 1934
Act Class Period, in order to maximize its earnings from Enron at
the expense of and in conflict with the interests of its retail
Plaintiffs identify as alleged undisclosed conflicts of
interest the following matters (see #122 ¶¶ 209-22). UBS, like
many investment banks, uses research analysts as “bird dogs” to
lure in customers and assist the banking department of the bank,
just as it used Barone and his “Strong Buy” recommendation, but UBS
never disclosed to the investing public or to Plaintiffs Barone’s
activities or pay.
Described as a “regular” occurrence, Mark
Altman, deputy head of the U.S. Equity Research for UBS, conceded
that, at the request of the investment bankers in UBS, the Equity
Department research analysts helped by initiating coverage of a
company as an incentive for that company to then do business with
the bank. Barone took clients to visit Enron, assisted in the
Enron-owned Azurix’s IPO, and participated in Enron-subsidiary
EOTT’s secondary and senior note offerings. Brian Barefoot, head
of PW’s investment bank until the completion of its integration
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Plaintiffs allege that Defendants, with scienter, violated
Section 10(b) of the 1934 Act and Rule 10b-5(a) and (c) by engaging
in a scheme to defraud or a course of business or conduct that
operated as a fraud upon Plaintiffs and the putative class and
deceived them into believing that the price at which they either
purchased or held their Enron securities during the Class Period43
was determined by supply and demand in the marketplace.
specifically, UBS participated in five transactions lacking a
legitimate business purpose, but employed to create a false public
with UBS, in February 2000 contributed money on behalf of the
investment banking department to the “research compensation pool”
for Barone’s efforts, including those related to Azurix and EOTT.
Each year Barone’s base salary and bonuses went up substantially.
With Barone’s help, in 2001 UBS was chosen as a co-lead manager
and/or co-manager on Enron investment banking deals.
The Court observes that the customers who were
purportedly lured in to do business with UBS are not members of the
Plaintiff class defined in the Third Amended Complaint and thus not
relevant to this suit.
The Class Period for the § 10(b), 1934 Act claims was
from November 5, 2000 to December 2, 2001.
The Class Period for the §§ 11 and 12 1933 Act claims was
from October 19, 1998 to November 19, 2001.
There are two proposed subclasses of PW
Plaintiffs under each of the two Acts. #122 at p. 6, ¶16. These
are (1) a class of purchasers of Enron common or preferred stock
on whose behalf the 1934 Act claims are alleged (¶ 16(I); (2) a
class of holders of Enron common or preferred stock with claims
under the 1934 Act (¶16(ii)); (3) and (4) classes of former Enron
employees with claims regarding Enron employee stock options under
Section 11 and Section 12 of the 1933 Act (¶ 16 (iii) and (iv),
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image of a strong Enron financial position:
two amendments to the
Equity Forward Contracts between UBS and Enron; underwriting notes
issued as part of Enron’s Osprey/Whitewing projects; commitment to
extend credit to Enron’s E-Next facility; and underwriting credit
linked notes in Enron’s Yosemite IV structure.
#122 ¶¶ 51-52.
Plaintiffs contend that UBS breached its duty to disclose to
Plaintiffs, based on the 1934 Act and on the brokerage relationship
between PW and Plaintiffs, the material information and knowledge
that UBS possessed because of its participation, with scienter, in
characterization of Enron’s financial position and of the concealed
conflicts underlying Warburg’s commercial banking relationship with
Enron and PW’s brokerage relationship with retail clients.
The undisclosed information was material in that a reasonable
investor would have considered it important in deciding whether to
invest in Enron securities.
Once that information became public,
Plaintiffs allege that it negatively impacted the price of Enron
securities and thus damaged Plaintiffs and the putative class.
Furthermore Plaintiffs conclusorily assert that “UBS’s actions
certainly show it acted with requisite scienter.” #122 ¶ 190.
also claim that UBS and Enron’s self-serving relationship took
precedence over and conflicted with the interests of these PW retail
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investor clients, from whom UBS had first bite at Enron employee
wealth (which it dubbed “the goldmine”) to generate retail fees and
income for UBS and to whom PW would funnel Enron and Enron-related
securities to transfer Enron’s risk to the marketplace.
Plaintiffs’ claims against PW under §§ 11 and 12 of the
1933 Act, 15 U.S.C. §§ 77k and 77l, on behalf of persons who
acquired Enron employee stock options and the common stock acquired
when they exercised those stock options, arise from PW’s alleged
role as the exclusive broker and stock option plan administrator for
Enron during the 1933 Act Class Period.
#122 ¶¶ 16(iii)-(iv), 26,
The complaint asserts that PW functioned as a “seller”44
and “underwriter”45 of Enron securities and is purportedly liable
for the materially false financial statements contained in Enron
prospectuses and registration statements. #122 ¶ 26.
According to the governing complaint, it was common
knowledge in the banking industry that Enron paid huge investment
banking fees to banks that provided it with credit capacity.
rapid expansion of Enron’s business from natural gas pipelines to
Under the 1933 Act, “sellers” and “underwriters” of
securities are required to make full and complete disclosure to
purchasing investors in public offerings. Section 11, 15 U.S.C.
Pages 95-96 (¶ 200) of #122 list the public offerings
of Enron securities for which PW or UBS served as underwriter.
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a global enterprise energy trading in the mid 1990's created a
substantial need for cash infusions, so from 1998 onward the UBS
Defendants worked hard to expand their credit capacity for Enron in
hopes of being allowed to obtain some of the more than $100 million
in non-credit related investment banking fees that Enron paid out
yearly. It also sought to obtain and retain high credit ratings to
allow it to accumulate senior unsecured long-term debt, essential
to its success.
Moreover beginning in 1992 with the SEC’s okay and
expanding as the years went by, Enron used mark to market accounting
(“MTM accounting”), including for its merchant investments, which
allowed Enron to recognize earnings long before its activities
generated any cash, resulting in an ever increasing gap between
income and actual funds flowing from operations (a “quality of
earnings” issue) by 1999. By December 31, 2000, approximately $22.8
billion of Enron’s assets were accounted for using MTM accounting,
representing 35% of its $65.5 billion total assets.
More specifically the complaint recites that Rocky Val
Emery (“Emery”), originally a financial adviser with PW, in 1993
learned from a client, Bill Roamy, an executive with Enron-owned EOG
Resources, that Enron was creating an “all employee” stock option
program and putting it out for bids from investment firms for a
contract to administer the Stock Option Program.
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#122 ¶ 65.
Seeking to make a lot of money, Emery put together a plan that
impressed Enron, and PW was chosen in 1994 to be the exclusive
Administrator of the Enron Employee Stock Option Plan, id. at ¶ 66,
with Emery given the primary responsibility for overseeing services
to Enron and the Enron employees who opened accounts. Emery’s group
in PW was known as the Emery Group, which continued to expand and
provide services to PW for four years. In 1998 PW and Enron entered
into a written, three-year contract which provided that when an
Enron employee chose to exercise his stock options, he had to do so
exclusively through PW.
# 122, ¶¶ 66-68.
Once he exercised the
stock options, he could either stay with PW or move his business to
#122 ¶ 67.
To retain that retail business, PW did
not charge Enron any fee to administer the Employee Stock Option
program, and PW charged the employees merely six cents per share to
exercise their options, and thereby insured that PW would receive
a stream of wealth from the arrangement.
#122 ¶ 67.
With its goal being to retain wealth generated by Enron
employees as they exercised their stock options, with its business
model PW was gradually capturing and retaining about 60% of that
#122 ¶ 70.
The way the arrangement worked, each time an
The complaint at ¶ 69 states that by 1999 about 45,00050,000 Enron employees participated in the Employee Stock Option
Plans. Of these, 25% signed up immediately by filling out the
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Enron employee received a grant of stock options, PW would send that
employee a packet of information regarding that stock grant, the
exercise price, vesting dates, tax treatments, and other data about
how to exercise those options and a form for the employee to apply
for a new PW account; in addition it would inform the employee as
a lure that PW charged a negligible six cents per share for the
employee to exercise his stock options.
#122 ¶¶ 67-68.
emphasized to the employee that it provided free services to
employees who opened PW accounts, including not only the Resource
Management Account itself ($85 per year value), but also free stock
option analysis and free financial plans worth hundreds of dollars.
Id. When an employee wanted to exercise his stock options, he could
If the employee was an insider or had options worth
$500,000 or more, he was transferred to Emery; otherwise he was
forwarded to one of the brokers in the Emery group on a rotating
When a PW broker answered the call, the broker would
immediately offer the employee a free “financial plan,” which would
then automatically assign the employee account to that broker, and
the employee became an advisory client of UBS under the Investment
Advisers Act of 1940.
#122 ¶ 71.
One broker described this
forms provided in the introductory packed; 25% opened accounts when
they exercised their stock options; and another 25% would slowly
flow in over a few months.
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lucrative flow of money to PW “like shooting fish in a barrel.”
#122 ¶ 72.
Furthermore to keep this money flowing, PW made a secret
“gentlemen’s agreement” with Enron, unknown to PW’s clients, that
customers should sell Enron stock, would advise them to exercise
their Enron options, and would say nothing about Enron that might
be perceived as negative.
While PW advisors were permitted to
advise their clients to diversify, those advisors had to speak with
clients in code language, in which they intended “diversify” to mean
“sell,” in violation of the rules of the National Association of
Securities Dealers, Inc. (“NASD”). #122 ¶ 74.
PW did not reveal
that communications between it and its clients were limited nor that
there would be no full disclosure.
These communications were
Furthermore, whenever a PW client asked
required to give the client the “Strong Buy” rating on Enron’s stock
by the managing director of the energy group at UBS Equity Research
Ron Barone,47 despite the fact that Barone did not intend that
It should be noted that ironically Plaintiffs’
complaint, if anything, bolsters Barone’s credentials to evaluate
energy companies (#122 ¶ 206):
Barone is the managing director in the energy
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rating to be a “buy” recommendation.48 #122 ¶ 76.49
group at UBS Equity Research and has been an
analyst since 1971. At UBS, he specializes in
independent power production and energy
marketing companies. He has been ranked on
Institutional Investors’ “All Star Team” for
27 consecutive years.
In 2001, Barone was
ranked No. 2 in the natural gas category by
Institutional Investors’ All-American Team.
Prior to joining UBS, Barone was the natural
gas analyst at Paine Webber, Inc.
The Court notes that the complaint alleges no facts that would
demonstrate that Barone acted with scienter in misleading those he
advised. As Defendants observe, #126 at p. 43, it was not “an
extreme departure from the standards of ordinary care” for Warburg
to permit Barone to publish his research even though others had
different views. Financial Acquisition Partners LP v. Blackwell,
440 F.3d 278, 287 (5th Cir. 2006)(defining severe recklessness for
scienter as “highly unreasonable omissions or misrepresentations
demonstrating an extreme departure from standards of ordinary
care”), citing Nathenson v. Zonagen, Inc., 267 F.3d 400, 408 (5th
Barone allegedly sent a Note with each rating to the
PW brokers to indicate that it was a rating, not a recommendation,
and that he expected they would read and understand it and discuss
with their client whether a stock was appropriate for the account
holder, but this information was never revealed to PW clients.
#122 ¶ 76.
The complaint asserts (#122 at ¶¶ 205 and 207-08),
UBS purports to have “Research
During the class period, it
represented to clients that the purpose of its
equity research was to benefit the investing
clients by (1) analyzing companies, industries
and countries to forecast their financial
performance; and (2) providing opinions on the
value and future behavior of securities. UBS
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represented that its equity research was
objective, had a reasonable basis and was
importantly, UBS represented that its Equity
Research would not be used by UBS “. . . to
advance its own interests over those of its
interests.” [emphasis in original #122] . . .
207. UBS’s fraudulent course of business
is evidenced, in part, by its (1) willingness
to allow Barone to continue coverage on Enron
when he espoused positions that UBS knew were
wrong; and (2) requiring, in the face of its
knowledge, that Barone’s “Strong Buy” Research
Notes be given to each and every client who
asked questions regarding Enron. Within the
UBS investment bank it was openly discussed
that Barone’s analysis and “Strong Buy” rating
was [sic] inconsistent with the investment
bank’s knowledge of Enron’s finances.
Moreover, the investment bank’s senior credit
officers admitted shortly before Enron’s
bankruptcy that Barone’s continuous “Strong
Buy” rating when highlighted by the press was
UBS allowed Barone to accept,
apparently blindly, Enron’s upper management’s
nonsensical explanations and ignore known hard
data. More importantly, UBS did not manage
Barone, took advantage of Barone’s contrary
rating to mitigate UBS’s exposure to Enron,
and used Barone to serve Enron, UBS’s “true
client,” by enhancing its investment banking
and retail revenues at the complete expense of
the Plaintiffs to whom UBS owed concrete
regulatory duties of disclosure.
Defendants point out that courts have dismissed claims
based on an investment bank’s failure to “monitor or correct”
allegedly incorrect research reports. #126 at p. 42, citing Podany
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Because many of the high level executives at Enron had
accounts at PW, when a “sudden firestorm of selling Enron stocks
began within the ranks of upper level executives at Enron” in mid
summer 2000, supported in the complaint by charts showing precise
sales by specific, identified executives on pp. 31-36 in #122,50 PW
v. Robertson Stephens, Inc., 318 F. Supp. 2d 146, 154, 156
(S.D.N.Y. 2004)(and cases cited therein)(“A securities fraud action
may not rest on allegations that amount to second-guesses of
defendants’ opinions about the future value of issuers’ stock-second guesses made all too easy with the benefit of hindsight”;
among “strong policy reasons why courts do not engage in . . .
second-guessing of forward-looking opinions” are that “relying on
an inference that an opinion that turned out to have been very
misguided must have been subjectively insincere would encourage
lawsuits every time a drop in share prices proves that an earlieruttered forward-looking opinion turned out to have been too
optimistic. . . . The securities laws are not intended as investor
insurance every time an investment strategy turns out to have been
Thus, the ultimate inaccuracy of defendants’
recommendations cannot be the sole basis for liability in a § 10(b)
action for misstatement of opinion. . . . [S]uch evidence is not
sufficient to allege scienter, and assertions that the opinions
must have been false because in hindsight it would have been more
prudent to make different recommendations do not constitute the
required particularized allegations of ‘provable facts’ supporting
an inference that the opinions were not truly held.”).
Defendants argue that these pages of trades do not
demonstrate knowledge by PW of Enron’s deteriorating financial
condition. Plaintiffs fail to indicate how many shares of Enron
stock each insider retained and whether he sold most of his
holdings or retained substantial exposure to Enron.
allegations of sales of the company’s stock by insiders, without
more, are insufficient to plead knowledge of the corporation’s
declining financial state even by those insiders. In re Advanta
Corp. Sec. Litig., 180 F.3d 525, 540 (3d Cir. 1999)(“The Third
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knew from these red flags that there was trouble at Enron.
thirteen months twenty-one insiders sold more than half a billion
dollars in Enron stock and generated hundreds of thousands of
dollars in fees for PW, which did not warn its retail clients, but
instead focused on keeping them invested in Enron securities.
As noted, Enron would not permit any adverse comments
about its stock.
Heritage Branch Manager Patrick Mendenhall,
Heritage Branch Sales Manager Willie Finnigan, and Rocky Emery
warned brokers in the branch on various occasions that if they
employees, they would be reprimanded, sanctioned, yanked from the
Circuit has held that it “will not infer fraudulent intent from the
mere fact that some officers sold stock.”); In re Enron, 258 F.
Supp. 2d at 593-94 (“The mere pleading of insider training without
regard to either context or the strength of the inferences to be
drawn is not enough”; “[w]hether there is an unusual or suspicious
pattern of insider trading may be gauged by such factors as timing
of the sales (how close to the class period’s high price), the
amount and percentage of the seller’s holdings sold, the amount of
profit the insider received, the number of other insiders selling,
or a substantial change in the volume of insider sales.”). That
a third party like PW simply knows about the trades by executing
or reading about them does not constitute knowledge of Enron’s
“true” financial condition.
The Court notes that in Advanta Corp., id., the Third
Circuit went on to say “But if the stock sales were unusual in
scope or timing, they may support an inference of scienter.”
Citing Shaw v. Digital Equipment Corp., 82 F.3d 1194, 1224 (1st Cir.
1996) (“[A]llegations of ‘insider trading in suspicious amounts or
at suspicious times’ may permit an inference that the trader--and
by further inference, the company--possessed material nonpublic
information at the time.”).
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Enron account, or even terminated.”
#122 ¶ 80.
crossed that line, the brokers were told about the incident and the
person was exposed.
The brokers were given a blunt notice: “If you
‘piss off’ Enron, ‘you’re done.’”
During the summer of 2000,
David Loftus, an employee in management, raised questions about
Enron’s business decisions to another passenger on a plane and was
subsequently criticized for doing so and admonished not to say
anything negative about Enron.
In 2001 Craig Ellis, a
consultant to help PW’s sales force with various investments, at a
sales meeting characterized the company as “‘cook the books’ Enron”;
Ken Logsdon, one of Rocky Emery’s right-hand men and an elite member
of the Emery Group, told Patrick Mendenhall, who then “silenced
Id. ¶ 81.
As an extreme example of Enron’s repression of broker
communications to clients, the complaint also goes into great detail
about a PW broker, Chung Wu (“Wu”), who worked with the Emery Group
at PW and whose client base was largely comprised of Enron employees
and former employees who had opened their accounts when exercising
their Enron stock options and whose wealth, he realized, was overly
and dangerously concentrated in Enron stock and unexercised Enron
stock options. #122 ¶¶ 78-79, 82-110. After intense due diligence,
Wu was concerned that expectations for Enron stock were far too
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optimistic. By March 1990, in spite of PW/UBS’s “Strong Buy”
recommendation for Enron stock, Wu warned his clients of Enron’s
Meanwhile between December 2000 and March
2001 PW sold more than $65,000,000 worth of Enron common stock for
four top Enron executives:
Ken Lay ($20,604,300), Jeff
Plaintiff Janice Schuette’s husband, about Enron’s deteriorating P/E
In April and May 2001, PW continued its
extensive stock sell-off for Enron executives:
Skilling ($5,216,400), Rice ($1,096,465) and Lou Pai ($45,833,700).
In June and July 2001, as Wu sent more warnings to his clients, UBS
continued to facilitate the executives’ liquidation of Enron stock:
Lay ($6,808,155), Skilling ($1,034,200), Rice ($18,993,991), and Pai
($2,215,605). In sum, while publishing “Strong Buy” recommendations
including putative Class Members, PW liquidated over $150,000,000
in Enron stock for five Enron executives.
#122 ¶¶ 87-91.
Wu continued to follow Enron’s deteriorating financial
position and in a August 21, 2001 final report to his clients he
urged them to divest themselves of Enron stocks and vested options.
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Several of Wu’s clients who were also Enron officers51 in anger
immediately terminated from PW.
#122 ¶¶ 93-104.
approval, PW sent out by email a retraction letter from Patrick
Mendenhall to all of Wu’s clients stating that Wu’s email was not
approved by PW and its contents were in violation of PW’s policies
and contrary to Barone’s “Strong Buy” recommendation.
#122 ¶¶ 105-
PW also purportedly immediately implemented a written
policy requiring compliance with the secret “gentlemen’s agreement”
to prevent another such incident.
PW management forbade its
financial advisors from giving any advice to their retail clients
regarding stock option issuers like Enron after August 21, 2001, and
instead ordered them to refer the clients to UBS’s current research
report and rating on the stock.
#122 ¶ 111.
Not only did Barone’s
deceptive “Strong Buy” rating remain unchanged until November 28,
2001, when it was merely downgraded to “Hold,”52 but even “the Chief
Specifically, Jeff Donahue, Enron’s Senior Vice
President of Corporate Development; Joan Amero, who worked for
Enron-owned PGE in Portland Oregon; and Mary Joyce, Senior Vice
President of Executive Compensation.
The complaint points out that beginning in June 2001,
UBS eliminated virtually all of its trading and credit exposure to
Enron by the time Enron filed for bankruptcy on December 2, 2001.
At the same time it continued to sell Enron securities and debt to
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Executive Office of UBS’s retail brokerage business, the man who was
responsible for the corporate gag policy on UBS brokers,” like the
clients, misinterpreted it to mean he should buy Enron stock.
¶ 112, 115.
In addition to “highlight[ing] UBS’s subordination of its
retail clients’ interests to its own and those of Enron,” Plaintiffs
claim that Wu’s termination illustrates “UBS’s coordination of its
entire structure to accomplish a common goal,” as well as “the
control Enron was able to exert over UBS, even during a period of
time when UBS had its hands full moving heaven and earth to rid
itself of liability and exposure to Enron.”
#122 ¶ 115.
UBS allegedly used its extensive information about Enron’s
financial status, gained in part through its active participation
in Enron transactions and financial manipulations53 in which UBS
played significant parts (1) to maximize its Enron-derived income
at the expense of and in conflict with the interests of PW’s retail
customers and (2) to limit UBS’s own exposure to Enron.
uninformed investors, including its retail clients. #122 ¶ 174-75.
By the first week of September UBS had begun its review to
downgrade Enron’s internal rating and determined by October that
such a downgrade would take place. #122 ¶ 174.
Including 1999 and 2000 amendments of existing Equity
Forward Contracts, the Osprey and Yosemite IV financial structures,
and the Enron E-Next Generation loan.
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complaint describes in substantial detail certain
and UBS’s unwinding in which UBS’s active participation gave it
financial condition and manipulations that provide the basis for
Plaintiffs’ securities fraud claims and which Plaintiffs contend UBS
clients,55 who purchased, acquired, and/or held Enron securities
UBS’s involvement with Enron in these transactions,
was designed to create a false appearance of Enron’s financial
position by concealing significant losses, as well as to generate
income and conceal secret loans to Enron, hidden by off-balance
sheet and mark-to-market accounting, in other words, actions in
which UBS aided and abetted Enron in its fraud on the investing
UBS Defendants identify and describe in detail (1) the
1999 and 2000 amendments to existing Equity Forward Contracts to
effect two undocumented and undisclosed loans to Enron (#122 ¶ 119146, 176-80), (2) the Osprey transaction (id. ¶¶ 147-155), (3) the
Yosemite IV structures (id. ¶¶ 156-160), and (4) the Enron E-Next
Generation loan (id. ¶¶ 161-66). The complaint also lists other
transactions on which UBS worked through which it purportedly
gained additional nonpublic information about Enron’s deceptive
acts: “Project Wiamea” or “Project Kahuna”; “Project Summer” or
“Enigma”; and “Enigma II.” #122 ¶¶ 167-73.
The nondisclosure of material information in violation
of a duty to disclose is a “deceptive” act prohibited by Section
10(b) and Rule 10b-5. In re Enron Corp. Sec., Derivative & “ERISA
Litig., 235 F. Supp. 2d 549, 569 n.9 (S.D. Tex. 2001), citing Santa
Fe, 430 U.S. 462, 470 (1977). At issue here is whether UBS owed
a duty to disclose to these investors.
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public generally, claims now invalidated as primary violations of
the 1934 Exchange Act and of Rule 10b-5 by Central Bank and
Stoneridge. Because UBS’s participation in these allegedly illegal
acts does not constitute a primary violation of the 1934 Act as to
Enron, the Court does not summarize them, but refers the parties to
allegations that, having gained substantial knowledge of Enron’s
deceptive acts by its involvement in these deceptive transactions,
PW breached its duty as broker to disclose to its own retail
investor clients, in violation of § 10(b) and Rule 10b-5, material
information that it gained about Enron’s fraudulent activities and
deteriorating financial condition.
#122 ¶¶ 116-73.
Starting in June 2001, Enron’s financial image began to
disintegrate rapidly, with Enron filing for bankruptcy on December
2, 2001. As part of its plan to transfer its Enron credit exposure,
in June and July UBS issued and sold $163 million worth of notes to
a Japanese investor with the payment obligation structured so that
if Enron filed bankruptcy or otherwise defaulted on an obligation
to UBS, UBS would not have to repay the notes. In July 2001 UBS
commenced selling Enron debt securities held by UBS to a wider group
of similarly unknowing investors, including its retail clients. UBS
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Convertible Senior Notes Due 2021, which Enron had issued and sold
in a private placement in February 2001 and which UBS began selling
while using its “Strong Buy” rating on Enron equity securities even
though UBS had a “Sell” and “Hold” rating on Enron debt securities.
It was in August 2001 that Wu sent his warning email to his clients
about Enron, leading to his swift termination.
The Equity Forward Contracts were derivative financial
instruments whose value fluctuated with the market price of Enron
on a specific future date, known as the “Settlement Date,”
Enron was contractually obligated to purchase from UBS, and UBS was
contractually obligated to deliver to Enron, a specified number of
Enron shares at a specific price, known as the “Forward Price.”
at a given time the market price of Enron stock was higher than the
Forward Price, the contracts were “in the money” for Enron, i.e.,
UBS owed Enron value in excess of the value Enron owed UBS.
market price of Enron stock was below the Forward Price, the
contracts were “out of the money” for Enron, i.e., Enron owed UBS
value in excess of the value UBS owed Enron.
be settled in two ways:
The contracts would
(1) they could be “physically settled,”
meaning that UBS would deliver shares to Enron and Enron would
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deliver cash to UBS or vice versa; or (2) they could be “net share
Under the latter method, if the contract net share
settled when the contract was “in the money” for Enron, UBS would
deliver to Enron the number of shares required at the current market
price to equal the net value of the Contract to Enron; if the
contract was “out of the money for Enron, Enron would deliver to UBS
the number of shares at market price required to equal the net
liability of Enron under the contract. The new value Enron promised
to pay or to give up was subject to an interest component as
expressed in the amendments.
Furthermore Enron had the contractual
right to terminate the Forward Contracts at any time.
In 1999 and
2000 UBS allegedly used these Equity Forward Contracts to effect
what in essence were two undocumented and undisclosed loans to Enron
that were not reported as debt and to support manufactured hedge
transactions between Enron and two related party entities to allow
Enron improperly to manipulate its income in violation of tax and
The two loan transactions kept more than
$260,000,000 in debt off Enron’s balance sheet and net losses
associated with merchant investments off its income statement. #122
Moreover Enron used the value to fund LJM, a special
purpose vehicle that Enron could use to hedge stocks that it could
not sell (“Illiquid Positions”) and to avoid prohibitions under GAAP
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and § 1032(a)56 of the Internal Revenue Code against a company (here
Enron) from recognizing as gain or loss what it received in exchange
subsequently devised a transaction to allow LJM to “purchase” Enron
stock directly from UBS to avoid GAAP and accounting restrictions.
Contracts permitted Enron and UBS to devise a largely similar
structures that allowed Enron maximum accounting benefit of the
value in the Equity Forward Contracts by circumventing Section 1032
of the Internal Revenue Code and GAAP and by avoiding “early
settlement” of the original Equity Forward Contracts (making the
transaction an undocumented, undisclosed loan) and making the
Amendments the effective Forward Contracts as of the amendment date.
The amendment to the first Forward Contract divided each contract
into two, and the same number of shares of Enron stock were
transferred but with new value, in return for Enron’s new promise
to pay or forgo more in the future.
UBS was to sell, transfer and
Section 1032(a) states, “Nonrecognition of Gain or
Loss–-No gain or loss shall be recognized to a corporation on
receipt of money or other property in exchange for stock (including
treasury stock) of such corporation. No gain or loss shall be
recognized by a corporation with respect to any lapse or
acquisition of an option, with respect to a securities futures
contract (as defined in section 1234B), to buy or sell its stock
(including treasury stock).”
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assign directly to LJM all of its rights, title and interest in the
assigned shares, leaving Enron out of the loop, as required to
achieve a hedge against the Illiquid Positions.
In addition to
providing Enron with a hedge for assets that could not otherwise be
hedged, the two restructurings of the Forward
Enron with hundreds of millions of dollars in capital for LJM and
a newly formed entity, Harrier, which Enron later used for numerous
illicit accounting and corporate purposes.
In June 2001 when Enron’s stock price was sinking to near
$50.00, UBS agreed to lower the trigger price on the Equity Forward
Contracts to $40.00.
A provision in these Forward Contracts gave
UBS the right to force Enron to settle the Contracts before their
Settlement Date if the price of Enron stock closed at or below a set
trigger price for two consecutive days.
On August 14, 2001 Enron
announced the resignation of its CEO, Jeff Skilling.
The next day
Enron’s stock price closed at $40.25, causing an uproar in UBS’s
corporate finance, equity risk management, credit, trading and legal
departments. After requiring Enron to provide nonpublic information
on the number, amounts, and trigger prices of equity forward
contracts with other parties, as well as information about Enron’s
recent trading in its own shares, UBS finally agreed to lower the
trigger price on stringent conditions, including a commitment that
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Enron settle the large equity forward contract at its October
maturity, that Enron increase the number of shares with which it
could net share settle the contracts, and that Enron provide UBS
with “Most Favored Nation” status, meaning that Enron would not
allow its other equity forward trades to have a higher trigger price
or more favorable unwind conditions than were permitted to UBS
Matters only got worse.
In response to Enron’s request
for a lower trigger price, UBS required Enron to settle the smaller
contract at maturity and continued to address the larger.
risk increased, the stock continued to drop in value, and in late
October UBS finally exercised its early termination rights, received
a cash payment to settle an equity swap and the remainder of the
forward contract, and immediately sold 2.2 million shares of Enron
stock that it held as a hedge to obligations under these contracts.
Because UBS understood the default risk Enron posed throughout the
period, UBS managed to unwind its positions timely, leaving it
little exposure to Enron before Enron declared bankruptcy.
In contrast to Barone, Stewart Morel (Morel”), debt/credit
analyst for Warburg, reported on Enron bonds and the company’s
ability to pay its debts.
Anyone at UBS could have a copy of
In his analysis of Enron’s public filings, Morel
observed an increase in debt consistently over the period from the
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third quarter of 2000 until Enron went out of business.
that Enron’s deteriorating credit and possible loss of investment
grade status would cause acceleration of its debt obligations, which
in turn would require Enron to have more short-term money to meet
Until November 2000, Morel listed Enron debt as a
“Buy”; after November 2000, as Enron’s debt increased, he lowered
it to “Hold”; and in early 2001, he changed it to “Sell.”57
20, 2001, he produced a report downgrading Enron bonds to “Reduce,”
i.e., reduce one’s holdings, sell.58
But unlike Barone’s “Strong
Buy” rating on stock, Morel’s “Sell” opinion on bonds was not
circulated to retail investors, even those encouraged by UBS to buy
Enron bonds after Morel downgraded Enron’s debt.
Plaintiffs allege that the ways UBS actively used Barone’s
In their response to the motion to dismiss, #148 at p.
32, Plaintiffs explain that “‘Buy’ meant that a bond was expected
to outperform other investments, a ‘Hold’ meant the bond was
expected to track the market and a ‘Sell’ meant the bond was
expected to under perform.”
Defendants challenge Plaintiffs’ allegations as false
and maintain that Morel’s opinion was not at odds with Barone’s,
as evidenced by the same reports that Plaintiffs cite.
contend that Morel’s June 2001 research report actually recommended
reducing exposure to Enron and buying ENE structured offerings.
#126 at pp. 44-45.
Defendants argue that the falsity of
Plaintiffs’ allegations about Morel’s research and recommendations
is evidenced by the reports that Plaintiffs rely on.
Lomuscio Decl., Ex. 19 (Morel June 21, 2001 research report,
UBS/LAM 069845-96) at 10.
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research and hid Morel’s was part of the scheme and artifice to
deceive its retail clients.
While UBS’s policy required financial
advisors to provide Barone’s research to retail clients and touted
its equity research as objective, fair, sound, and founded on a
reasonable basis, UBS did not reveal the material information that
its analysts received substantial amounts of money for, at the
request of, the Bank, covering companies and cozying up to corporate
management to obtain investment banking business.
#122 ¶ 224.
industry standard, according to Brian Barefoot, requires that a bank
that discovers corporate malfeasance should stop analyst coverage
on the stock, suspend the stock and the research activity, and
investigate. #122 ¶ 226. According to the complaint, UBS took none
of these steps, but instead relentlessly hawked Barone’s “strong
Buy” opinion to deceive the investing public for UBS’s own gain.
recommendation specifically stated that the rating was intended to
be distributed only to major institutional investors, PW required
its brokers to send it to their retail clients across the board,
particular retail client.
#122 ¶¶ 263-64.
Any broker that refused
to promote Enron securities aggressively and rapidly, like Wu, was
quickly terminated. Id. ¶ 264-65. No negative comments about Enron
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were tolerated and any advice to sell had to be characterized as for
Id. at 265.
Lampkin, Ferrell, and Swiber’s claims under the 1933 Act’s
misrepresentations and omissions identified on the restatement of
the Enron financials before November 8, 2001 in Enron’s formal
notice, filed Form 8-K,59 and subsequently Enron’s restatement of
The complaint, #122 ¶ 236 asserts that this Form 8-K
stated that Enron would be providing material information to
investors about the following matters:
A required restatement of prior period
recording the previously announced $1.2
billion reduction to shareholders’ equity
reported by Enron in the third quarter of
2002; and (2) various income statement and
balance sheet adjustments required as the
result of a determination by Enron and its
auditors (which resulted from the information
made available from further review of certain
unconsolidated entities should have been
consolidated in the financial statements
pursuant to generally accepted accounting
Enron intended to restate its financial
statements for the years ended December 31,
1997 through 2000 and the quarters ended March
31 and June 30, 2001.
As a result, the
previously-issued financial statements for
these periods and the audit reports covering
the year-end financial statements for 1997 to
2000 should not be relied upon.
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financials in Enron’s November 19, 2001 Form 10Q for Quarter Ended
September, 30, 2001.
Identifying the date, file numbers, number of
shares, relevant benefit plan and total value, Plaintiffs list the
Registration Statements (#122 ¶ 230) accompanying the Prospectuses
pursuant to which they acquired options to purchase Enron equity
securities and the exercise of those options to receive Enron common
undisputedly contained inaccurate financial statements and other
information and omitted material information is evidenced by the
fact that they had to be restated.
#122 ¶ 235.
The Form 8-K
* The accounting basis for the $1.2 billion
reduction to shareholders’ equity.
* The Special Committee appointed by Enron’s
Board of Directors to review transactions
between Enron and related parties.
Information regarding the LJM1 and LJM2
limited partnerships formed by Enron’s then
Chief Financial Officer, the former CFO’s role
relationships and transactions between Enron
and the partnerships, and the economic results
of those transactions as known thus far to
Enron, which are outlined [in the attached
Tables to the report].
* Transactions between Enron and other Enron
The complaint asserts that copies were provided of the
Stock Option Plans of 1991, 1994, and 1999, along with any
restatements or amendments to them.
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revealed what years and areas had to be restated, what had to be
disclosed; it further disclosed that Enron’s financial restatement
would include a reduction to reported net income of about $96
million in 1997, $113 million in 1998, $250 million in 1999, and
$132 million in 2000, increases of $17 million for the first quarter
of 2001, and $5 million for the second quarter, and a reduction of
$17 million for the third quarter of 2001.
The Form 8-K explained
that these changes to net income were caused by the retroactive
consolidation of JEDI and Chewco, commencing in November 1997, which
increased Enron’s debt by approximately $711 million in 1997, $561
million in 1998, $685 million in 1999, and $628 million in 2000.
The Prospectuses were false and misleading in part because they
incorporated by reference all of Enron’s 10-Ks from 1997-2001, which
misrepresented Enron’s financial results for all those years.
November 8, 2001 Enron’s restatments reflected a charge to earnings
of approximately $500 million, or about twenty percent of earnings
during that period.
On November 19, 2001 Enron filed a Form 10-Q,
showing for the first time a November 9, 2001 downgrade to BBB,
which triggered a demand for $690 million from Enron, associated
with Whitewing, in which UBS was involved,61 which sum Enron was
Plaintiffs state that the Whitewing structure was
discussed in #122, but the Court is unable to find any mention of
Whitewing other than a single, unexplained reference to
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unable to pay it. #122 ¶¶ 238-40.
Regarding Section 12(a)(2), Plaintiffs allege that PW
qualifies as a “seller” under the statute because PW successfully
promoted or solicited the purchase of securities to serve its own
financial interests or the interests of the securities owner.
“Brokers and other solicitors are well positioned to control the
flow of information to a potential purchaser, and, in fact, such
persons are the participants in the selling transaction who most
often disseminate material information to investors.”
Glenns, Inc., 876 F.2d 207, 510-12 (5th Cir. 1989)(“The Court has
recently reformulated the test for ‘seller’ status in light of the
Supreme Court’s decision in Pinter v. Dahl . . . . [T]he seller [is]
either one who owns a security and transfers it for consideration
or one who successfully promotes or solicits the purchase ‘motivated
at least in part by a desire to serve his own financial interests
or those of the securities owner.’”), cited by In re Azurix Corp.,
198 F. Supp. 2d 862, 892 (S.D. Tex. 2002)(“For potential § 12(a)(2)
liability to exist, defendants must have passed title to the
solicited the transaction in which title passed to them,”), aff’d,
332 F.3d 854 (2003).
PW was a “seller” under Section 12(a)(2) “(1)
Osprey/Whitewing in ¶ 258 of #122.
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because of its direct participation in the timing and exercise of
Enron employees’ stock options on Enron’s behalf and its active
transactions; and (2) because [PW’s] direct participation and active
solicitation/promotion of Enron securities was motivated by and
resulted in unprecedented amounts of collateral enrichment to [PW].”
#122 ¶ 267.
Its function was greater than as simply a conduit for
Enron employees’ receipt of Enron securities.
Agreement between PW and Enron to administer exclusively Enron’s
stock option plans for more than 27,000 individuals for over five
years provided PW with a three-pronged approach to capture great
wealth: (1) PW required Enron employees to open an account with PW
before they could exercise their stock options, after which they
were guided to PW’s phone bank of advisors and instructed how to
materials, including a copy of Guide to Exercising Your Stock
Options Online about PW’s services, to convince them of the need for
assistance from a PW financial advisor in investing in matters
purportedly too complicated for them to navigate alone; and (3) they
were given stock option analysis and financial planning services
The advisors were frequently reminded that they were
not to provide any opinion regarding the exercise of the stock
options until the employee had set up an account with PW.
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free of charge.
As permitted by the Agreement, PW would then
aggressively pursue further investment business with the employees
and enrich itself collaterally. PW did not confine itself to simple
administrative services in exercising stock options, but sought to
provide voluminous free financial services to these customers, such
as the Guide to Exercising Your Stock Options Online publication,
including UBS’s equity research analyst reports and ratings.
controlling officers and directors at Enron when it sold over
$550,000,000 in the insiders’ Enron stock in the latter part of 2000
and first half of 2001, and would then strive to control the funds
generated from these sales.
Thus PW enriched itself directly and
collaterally through the administration of the stock option plans.
#122 ¶¶ 255-62.
Finally, regarding the § 12(a)(2) claims against PW,
Plaintiffs Lampkin, Ferrell, and Swiber insist they are grounded
entirely in negligence and/or strict liability, and not in fraud.
The same Plaintiffs, themselves, and on behalf of the
putative class, also sue PW as underwriter for untrue statements of
material fact or omissions in the S-8 Registration Statements filed
with the SEC, identified in ¶ 230 of #122, under Section 11(a)(5),
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statements of material fact or omissions that are the basis of
Plaintiffs’ § 12(a)(2) claims are also the basis of their § 11(a)
The expansive statutory definition of “underwriter,” §
2(a)(11) of the 1933 Act, covers any person who participates
directly or indirectly in the distribution of securities.
Louis Loss and Joel Seligman, Securities Regulations 3d, § 2-A
(2001), Plaintiffs list five basic underwriting techniques, some
“ strict or ‘old fashioned’ underwriting, 
firm commitment underwriting,  best efforts underwriting, 
competitive bidding, and  shelf registration.”
functioning as a gatekeeper between the United States securities
markets and issuers, the underwriter provides the issuer with a
strong advocate in the secondary market and sponsorship of the
Section 77k(a)(5) states in relevant part,
In any case any part of the registration
statement, when such part became effective,
contained an untrue statement of a material
fact or omitted to state a material fact
required to be stated therein or necessary to
make the statements therein not misleading,
any person acquiring such security (unless it
is proved that at the time of such acquisition
he knew of such untruth or omission) may,
either at law of in equity, in any court of
competent jurisdiction, sue--every underwriter
with respect to such security.
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stock, and it ensures that the issuer provides truthful and adequate
information upon which the investing public can make an informed
investment decision. After investigation of the issuer, performing
due diligence, and approving the issuance, the underwriter often
metamorphoses into a “market maker” to distribute the shares among
private individuals and institutional purchasers to insure a good
price in the offering and adequate trading in the shares. Essential
to the issuer, the underwriter makes a market for the stock by
providing research and analysis on the company for investors,
organizing communications with investors and potential investors,
and helping the company to create or maintain a following in the
investment community. It times purchases and sales of the company’s
stock in the market to give the company’s stock necessary liquidity
and thus stabilizes trading prices.
The investing public depends
upon underwriters to protect them from the Enrons of the world.
served as a market maker for Enron. #122 ¶¶ 276-78.
As noted, under Section 2(11), 15 U.S.C. § 77b(11), a
statutory underwriter is defined functionally on the basis of its
relationship to a particular offering and reaches “any person who
has purchased from an issuer with a view to, or offers or sells for
an issuer in connection with, the distribution of any security, or
participates or has direct or indirect participation in any such
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undertaking, or participates or has a participation in the direct
or indirect underwriting of any such undertaking . . . .”
PW has promoted, offered, and sold for Enron and has had a
direct or indirect participation in the offer and sale and the
distribution of securities at issue into the initial and secondary
security markets. PW meets both the seller aspect of an underwriter
(Section X of #122, pp. 87-107) and the participation aspect of the
statutory definition of “underwriter” (Section XII).
construes the words “participates” and “participation” as covering
any person “enjoying substantial relationships with the issuer or
underwriter, or engaging in the performance of any substantial
functions in the organization or management of the distribution.”
Op. of Gen. Counsel Securities Act Release No. 33-1862 (Dec. 14,
1938). PW, in consideration for the exclusive right to broker Enron
employees’ exercise of stock options under the Stock Option Plans,
took on the administration of the Stock Option Plans.
Enron “outsourced the organization and management of its [Stock
Option Plans] to PW, which, as a licensed and registered brokerdealer, could be a market maker providing sponsorship in the
financial markets to support the value of the Enron securities.
took on the task of selling the stock to the investor, giving him
advice and an explanation of his plan, explaining how the exercising
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of his options fit in with overall investment goals, whether and
when to exercise and sell or exercise and buy, or not exercise their
stock options at all and
timing large blocks of exercises into the
market to avoid price fluctuations despite the huge amount of
insider stock being sold on the market in late 2000 and early 2001.
financed Enron employees’ exercise of stock options through a
broker-financed exercise pursuant to provisions of Regulation T of
the Federal Reserve Board (explained in #122 ¶¶ 283-84).
Plaintiffs also allege that because PW contractually
arranged to be the exclusive conduit for Enron securities being
placed into the hands of Enron employees and Enron affiliates’
employees through the Stock Option Plans, meant that PW was the sole
gatekeeper to the initial and secondary markets for the 100,000,000
securities issued via the process registered by the Registration
A contractual arrangement with an issuer whereby a
broker-dealer becomes the administrator, organizer, manager, and
exclusive conduit for the distribution of hundreds of millions of
securities clearly falls within the statutory definition of an
underwriter under section 2(a)(11), 17 U.S.C. § 77b(a)(11),64 insist
Section 2(a)(11) states,
The term “underwriter” means any person who
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Statutory underwriters include any person who is
“engaged in steps necessary to the distribution of security issues.”
SEC v. Chinese Consol. Benevolent Ass’n, 120 F.2d 738, 741 (2d Cir.
1941); SEC v. Kern, 425 F.3d 143, 152 (2d Cir. 2005). The Agreement
transactions. Furthermore, the statutory definition of underwriter
includes an exemption from that designation for “a person whose
interest is limited to a commission from an underwriter or dealer
not in excess of the usual and customary distributors’ or sellers’
PW cannot argue that it is so exempt because it
received only the usual and customary commission in connection with
the distribution of the securities covered by the Registration
Statements directly from an underwriter or dealer since PW received
its compensation for being the exclusive conduit into the market for
has purchased from an issuer with a view to,
or offers or sells for an issuer in connection
with, the distribution of any security, or
participates or has a direct or indirect
participation in any such undertaking; but
such term does not include a person whose
interests is limited to a commission from an
underwriter or dealer not in excess of the
usual and customary distributors’ or sellers’
As used in this paragraph the
term “issuer” shall include, in addition to an
issuer, any person directly or indirectly
controlling or controlled by the issuer, or
any person under direct or indirect common
control with the issuer.
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the subject securities from the investor, not from the underwriter
In sum, argue Defendants, under § 2(11) of the 1933 Act
PW qualifies an “underwriter” of securities issued pursuant to
Registration Statements and is subject to liability under Section
11 for untrue statements of material facts and omissions of material
securities for Enron and it participated directly and indirectly in
the sale and distribution of Enron stock to Lampkin, Ferrell and
Swiber and other employees of Enron or its affiliate companies by
and through their employee stock option plans.
PW asserts its
Section 11 claims, too, are grounded in negligence and/or strict
liability and disclaims any allegation that may be construed as
fraudulent and/or knowing or reckless conduct.
Defendants’ Motion to Dismiss (#125 and 126)65
Complaint alleges claims of a scheme under § 10(b) of the 1934 Act
that is no different from, and even weaker than, the scheme claims
Because the Court has not considered the Enron
Bankruptcy Examiner’s Report, the results of two NASD Arbitrations,
regulatory activity against UBS and the fact that other counsel
have not sued UBS in connection with Enron litigation, since none
of these challenged factors control the determinations of this
Court in this case, the Court does not address Plaintiffs’
objections to them.
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in Newby asserted against Deutsche Bank and Barclays, which were
dismissed by this Court in the Newby litigation. See Newby v. Enron
Corp. (In re Enron Corporation Securities, Derivative & “ERISA”
Litig.), H-01-3624, #4735.
First, Warburg allegedly participated in transactions that
misrepresented to the public Enron’s financial status and damaged
Plaintiffs (i.e., PW’s retail customers) in five ways, none of
which, Defendants contend, stated a viable primary liability claim
under § 10(b):
by underwriting a follow-on offering66 of Osprey
notes; underwriting a follow-on offering of Yosemite IV creditlinked notes; extending credit to E-Next Generation LLC; and twice
A follow-on offering is an issue of stock that
comes after a company has already issued an
initial public offering (IPO).
offering can be diluted, meaning that the new
shares lower a company’s earnings per share
(EPS), or undiluted, if the additional shares
A company looking to offer
additional shares registers the offering with
regulators, which includes a prospectus of the
Unlike an IPO, which includes a price
range that the company is looking to sell its
shares, the price of a follow-on offering is
market-driven. . . . The price of a follow-on
offering is usually offered at a small
discount from the closing market price on the
day of the transaction.
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settling existing equity forward contracts by delivering stock to
purportedly not only participated in transactions that were used by
Enron to distort Enron’s financial statements, but its involvement
revealed to “a score of UBS officers . . . significant amounts of
information regarding Enron’s questionable business activities” and
allowed UBS to “undert[ake] trading activities to eliminate its own
credit exposure to Enron for its own benefit.
#122 ¶ 52.
not give its own retail investor clients this information nor inform
Id. at ¶ 25.
Second, Warburg limited its financial
information. In addition, Warburg did not attempt to prevent Barone
from rating Enron stock a “Strong Buy” even when Warburg knew that
the actual condition of the company was the opposite.
did not disclose to its retail investing customers the material,
nonpublic, negative information about Enron and the manipulation of
Enron’s public financial appearance, partly accomplished by UBS and
allegedly known by Warburg bankers.
Last, PW chose not to disclose
administration of Enron’s employee stock option program.
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listed above, constitute aiding and abetting and are thus not
cognizable under § 10(b) and Rule 10b-5.
As in Newby, Plaintiffs
in this action allege that Warburg defrauded investors by extending
“disguised loans” to Enron and participating in concealed offbalance-sheet financings.
When addressing claims in Newby against
Deutsche Bank and Barclays, this Court has already ruled that such
claims constitute aiding and abetting and cannot give rise to a
decisions in Central Bank and Stoneridge.
Third, for the required element of scienter, even though
Plaintiffs recognize that Warburg and PW were separate and distinct
entities during the putative Class Periods, with no ownership
interests in each other, Plaintiffs fail to plead with the required
specificity which individual employee at which defendant had what
knowledge of wrongdoing or wrongful intent for 1934 Act and the
Southland, 365 F.3d at 365.
The few times the
complaint does identify an employee who knew something about Enron,
the allegations of knowledge that were made were impermissibly
misrepresentations or misleading omissions by either Defendant with
misrepresentation or omission. Furthermore, since the two entities
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are corporate Defendants, Plaintiffs are required, but have failed,
to plead facts giving rise to a strong inference that an identified
employee of each Defendant employee acted with scienter as to each
misrepresentation and/or omission.
Southland, 365 F.3d at 366-67.
relationship” with Plaintiffs that might give rise to a duty to
Nor have Plaintiffs pleaded loss causation, Defendants
While they plead that Enron’s “financial collapse” was
caused by its inability “to service its debt,” Defendants point out
that the alleged fraudulent brokerage practices at PW relating to
purchases or sales of Enron stock by PW’s retail brokerage customers
had no relation to Enron’s purported fraudulent financial statements
and were disclosed only after Enron’s stock price had plummeted to
Finally, regarding the 1933 Act claims against PW under
Sections 11 and 12 on behalf of persons who acquired Enron stock
options and common stock through the exercise of those options (¶
¶16(iii)-(iv) and 230), there was no “sale” involved in Enron
The purported false Forms S-8 targeted by the Third
Amended Complaint registered only Enron stock, not employee stock
options, and therefore could not have constituted “registration
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statements” or “prospectuses” offering Enron employee options for
which PW is an alleged underwriter.
Moreover, an employer’s grant
of stock options to its employees is not a “sale” of securities, so
PW could not have been an “underwriter” of options triggering
Section 11 liability, nor liable for “offering or selling” options
under Section 12(a)(2).
Last, there are no facts alleged showing
that any named Plaintiff has standing to assert 1933 Act claims
based on shares acquired by exercising an employee stock option.
While Warburg and PW are separate legal entities with no
Plaintiffs do not distinguish between the two, often using “UBS” to
not only refer to both, but also to nonparty parent corporation UBS
AG, and the term “Defendants” to include both Warburg and PW.
Defendants emphasize that in opinions in Newby, this Court
detailed the legal duties owed by banks to Enron investors, like
Defendants charge that because Plaintiffs here
allege no facts distinguishing their claims against Warburg from
those dismissed against banks in Newby, Plaintiffs’ “banking” claims
against Warburg must be dismissed for the same reasons.
fail to plead primary scheme liability against Warburg.
example, in Enron, H-01-3624, slip. op. (#4735), at 180 (S.D. Tex.
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2006), this Court wrote,
The . . . allegations that Deutsche Bank
provided standard [banking] services, i.e.,
underwrote billions of dollars of Enron-related
securities, lent money to Enron, provided
commercial banking and investment banking
services to Enron, and earned a lot of money in
fees from Enron, or that its employees who
performed due diligence on Enron projects had
an obligation to ensure that statements in
offering memoranda are full, fair and accurate,
in an effort to plead scheme liability under §
10(b), are too general and clearly lack the
kind of specific facts that would support a
strong inference of scienter under the PSLRA.
Moreover, . . . these acts constitute aiding
and abetting and thus are not actionable under
§ 10(b) in this case pursuant to the holding of
In sum, each of the five transactions in which the
complaint asserts that Warburg participated fail to state a claim
for two reasons:
none states a primary violation of Section 10(b)
and Rule 10b-5 and Plaintiffs fail to plead particular facts giving
rise to a strong inference that Warburg acted with scienter.
In the same Opinion and Order (#4735 at 183 & n.158), this
Court dismissed claims that Deutsche Bank violated Section 10(b) and
Rule 10b-5 by underwriting debt issued by the Osprey Trust or Enron,
that Deutsche Bank structured Osprey to fund Whitewing while knowing
that Enron sold assets to Whitewing at inflated values to falsify
Enron’s earnings, and that Deutsche Bank designed Osprey to transfer
billions of dollars of debt off Enron’s balance sheet.
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Lead Plaintiff in Newby did “not explain specifically what was
inherently deceptive in these structurings created by Deutsche
Bank,” this Court concluded, “Once again, without specific facts
demonstrating that Deutsche Bank established an innately illicit
deceptive entity or device, Deutsche Bank was at most merely aiding
and abetting any subsequent deceptive use of these entities by
Enron, the trustees, and Enron’s auditor.”
The Court also
rejected allegations that Deutsche Bank’s underwriting of various
securities violated Section 10(b) and Rule 10b-5.
Similarly in the instant action, in its services as one
of several co-managers in a follow-on offering of Osprey notes,
Warburg did not “structure” Osprey. Not only have Plaintiffs failed
to identify any “innately deceptive entities or devices” employed
by Warburg in the Osprey offering, but they did not allege that they
purchased any notes in the Osprey offering, nor could they, since
the Osprey notes were sold in private placements to qualified
Newby, H-01-3624, #4735 at 23.
Even if a
bank structured and led the underwriting syndicate of the Osprey
offering, it would at most be aiding and abetting of Enron’s fraud.
Warburg’s lesser role as a mere co-managing underwriter of that
offering could not be more.
Not only have Plaintiffs failed to allege a primary
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violation by Warburg, but they do not plead scienter with the
No facts are pleaded showing that Warburg
bankers knew a transaction was fraudulent.
Even their claims that
Warburg performed such recklessly inadequate due diligence that it
did not discover that “Enron used the Osprey structure to generate
structure” (#122 at ¶ 155) “are too general and clearly lack the
kind of specific facts that would support a strong inference of
scienter under the PSLRA” (Newby, H-01-3624, #4735 at 189).
Newby this Court dismissed the Section 10(b) and Rule 10b-5 claims
against Deutsche Bank, including the claim that Deutsche Bank
actually knew (not merely that it acted recklessly in failing to
know) that “Enron sold assets to Whitewing at inflated values to
falsify Enron’s earnings.”
Id. at 183 & n.158.
As for Warburg’s alleged trades in Zero Coupon Notes, in
the Newby action, id., Deutsche Bank was the “selling security
holder” of $169 million worth of Zero Coupon Notes, more than 200
times the amount of Zero Notes sold by Warburg, while Deutsche Bank
was also one of five initial purchasers in the initial Rule 144
private placement of the Zero Coupon Notes.67
#127, Declaration of Richard J.L. Lomuscio, Exhibit 4
(Enron Corp. Form 424B3, filed Aug. 17, 2001) at 1 (Warburg listed
as “selling security holder” of $800,000 worth of Zero Coupon
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entity participated in that private placement.
In H-01-3624 the
Newby Lead Plaintiff asserted that a bank “provided its services as
underwriter of Zero Coupon Notes (#4735 at 183), and in Giancarlo,
et al. v. UBS Financial Services, Inc., et al., H-03-4359, #30 at
42, Plaintiffs claimed that a bank “purchased some of [this]
unsecured Enron debt”: the Court found the allegations “clearly .
inadequate to sustain a fraud claim.”
That is all that
Lead Plaintiffs in this action assert against Warburg regarding the
Zero Coupon Notes (#122 at ¶ 175), so they also fail to state a
fraud claim against Warburg.
In addition the complaint fails to plead facts that even
hint than any alleged trades in the Zero Coupon Notes were based on
nonpublic information or were meant to defraud investors.
no allegation of any connection between research reports rating
Enron stock a “Strong Buy” and Enron’s SEC filing at the same time
listing UBS AG and Warburg as selling security-holders of these
notes other than their proximity in time.
In Newby, H-01-3624, #4735 at 183, Deutsche Bank was
dismissed despite allegations that it underwrote credit-linked debt
Notes; Nonparty UBS AG, London Branch, listed as a “selling
security holder” of $250 million of those notes), and Exhibit 5
(Enron Corp. Form 424B3, filed July 25, 1001) at 7 (listing
Deutsche Bank as one of five initial purchasers of Zero Coupon
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Barclays was dismissed even though it executed prepay transactions
relating to the Yosemite IV Credit Linked Notes Offering because the
Court found the prepays were “not per se illegal.” Id., #4874 at 61.
Plaintiffs here do not assert that Warburg participated in a prepay,
but do charge that Warburg defrauded them by underwriting the
credit-linked notes in Yosemite IV (#122 ¶ 52) when it knew that
“Enron used these Yosemite transactions to obtain what in economic
substance were loans, despite their public characterization as funds
flow from operations” (#122 ¶ 156).
The fraud in this case was
effected by Enron, not by the underwriting of the notes, argue
allegations that Warburg was aware of the prepay are, as this Court
found in Newby, #4735 at 180, “too general and clearly lack the kind
of specific facts that would support a strong inference of scienter
under the PSLRA,” and fail to plead a primary violation of § 10(b)
or Rule 10b-5; as this Court again opined regarding Barclays,
“prepays are not per se illegal.”
In both suits Plaintiffs fail to
explain the mechanics of Yosemite IV, no less identify anything that
made it improper.
Last, #122 at ¶ 160, Plaintiffs allege that UBS
“either knew . . . or was severely reckless in not knowing about the
commodity prepay aspect of the transaction . . . and that the prepay
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transaction was nothing more than yet another disguised loan to
Defendants respond that this statement, to, “is conclusory
and wholly inadequate to plead scienter.”
Id., citing Newby, #4735
Defendants point out that the amendments to the two Equity
Forward Contracts between UBS and Enron occurred in mid-1999 and
affiliated with Warburg or UBS AG.
The complaint asserts the
contracts were actually undocumented and undisclosed loans to Enron,
which were used “to support manufactured hedge transactions between
Enron and two related party entities, which Enron used improperly
to manage its income” and to keep more than $260,000,000 in debt
from its balance sheet. #122 ¶¶ 121-22.
The complaint alleges that
UBS entered into these loans knowing that they would not be reported
as debts and that the manufactured hedge positions would be employed
to shore up MTM accounting of income by denying the possibility of
losses in connection with those assets.
Id. ¶ 122.
insist that the allegations that Warburg helped Enron by extending
disguised loans of any kind at most constitute allegations of aiding
and abetting Enron’s fraud.
Defendants conclude that the “Complaint’s factual allegations were
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a form of ‘net settlement’ that discharged Warburg’s pre-existing
obligations to Enron and struck new forward contracts.” #122 ¶ 120.
Contrary to Plaintiffs’ claims, the two Equity Forward Contracts
were no more loans than any other forward contract.
correctly states that “the value of the contracts, but not their
terms, fluctuated with the market price of Enron stock.”
While Plaintiffs highlight the “interest component in the two
Equity Forward Contracts,” Defendants note that such contracts
typically incorporate an “interest component” in that the forward
price is higher than the market price.
See David F. Levy, Towards
Proposals for Taxing Prepaid Forwards, Equity Swaps,
and Certain Contingent Debt Instruments, 3 Fla. Tax. Rev. 471, 481
(1997)(to determine a forward contract price, “the parties add to
the current spot price of the underlying property . . . the costs
that the seller will incur in holding the underlying property (i.e.,
insurance, storage, and interest.)”).
Levy describes forward
contracts, id. a 478-79, as having “fixed price terms” such that one
party can “benefit economically from a downward movement” in the
price of the underlying asset and the other “benefit[s] economically
from an increase in the price” of the asset.
transferred to the SPE Harrier Enron stock worth $254 million in
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April 2000 after the stock increased in value since June 1999; in
October 2001 Enron paid Warburg $153 million after Enron’s stock
settlement” that discharged Warburg’s pre-existing obligations to
Enron and struck new forward contracts, i.e., “reset Warburg’s
obligations to Enron to zero, allow an Enron SPE to receive Enron
stock, and put in place new equity forward contracts reflecting the
then-current market price of Enron stock.”
#122 ¶ 120; #126 at 22-
23 (detailing the two restructurings).
Furthermore, even if the amendments to the Equity Forward
Contracts had been undisclosed loans, the complaint still fails to
state a claim against Warburg because Plaintiffs’ allegations
constitute at most aiding and abetting Enron in concealing its debt
and falsely representing its financial condition to potential
investors. Furthermore there is nothing innately illicit about
equity derivative transactions, which are common and legitimate
transactions used by the world’s largest companies.
Decl Ex. 11 (International Swaps and Derivatives Association,
Securities Industry Association, and The Bond Market Association,
amicus brief in Enron Corp. v. UBS AG, Adv. Proc. No. 03-93373
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(Bankr. S.D.N.Y.) at 1 and 12.68
And while Plaintiffs allege that
these restructurings gave Enron seed money to create the LJM Cayman
and Harrier SPEs and that Warburg designed them (#122 ¶ 122 and ¶
127), the claim still fails to state a claim because it was not the
creation of such an entity that violated § 10(b), but Enron’s
alleged use of it to achieve off-balance-sheet treatment of debt
that violated the law.
Generation LLC Credit Facility was intentionally kept off Enron’s
balance sheet to present a false picture of Enron’s financial
conditions to conceal a $600 million loan to Enron.
respond that again Plaintiffs fail to plead a primary violation of
As this Court wrote in Newby, H-01-3626, #4735 at 181,
“[A] bank making a loan to a borrower, even where it knows the
borrower will use the proceeds to commit securities fraud, is aiding
and abetting,” and “‘[f]inancings and investments are not sham
transactions if there is no suggestion that the transactions were
something other than what they purported to be.’”
Citing In re
Parmalat Sec. Litig., 376 F. Supp. 2d 472, 505 (S.D.N.Y. 2005). The
“Equity derivative transactions may be settled with
cash payments, the physical exchange of cash for securities, or by
delivering ‘a sufficient quantity of a designated security in lieu
of cash’-i.e., net share settlement. Id. at 2 & n.2.” #126 at 27
n.28, citing id., Ex. 11.
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E-Next facility was not a sham:
a number of banks lent money for
its legitimate business purposes of purchasing turbines and other
equipment during the first of its three phases and finding locations
and constructing gas-fired electric generating plants during its
Plaintiffs do not claim that Enron used the funds for
anything else, not to mention that anyone at Warburg knew about
The primary violation was in Enron’s auditing and concealing
the transactions. Nor do Plaintiffs allege scienter as to Warburg.
Even if Warburg employees knew that E-Next would be illegally kept
off Enron’s balance sheet by Enron, “the creation of an unqualified
SPV [does not] violate
§ 10(b), but the use of it to obtain that
unwarranted off-balance-sheet treatment [constitutes] a primary
H-01-3624, #4874 at 62.
As noted Warburg and PW are legally separate entities,
Warburg is not a broker, and Warburg owes no duty to disclose to
PW’s retail investor clients.
Defendants also insist that the complaint fails to plead
with particularity what material, nonpublic information about Enron
who at Warburg possessed and when.
Finally, Defendants insist, Warburg did not unlawfully
trade on insider information.
Plaintiffs’ allegation that “UBS
undertook trading activities to eliminate its credit exposure to
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Enron for its own benefit, while in possession of . . . material,
non-public information [learned during various transactions with
Enron and regarding ‘Enron’s questionable business practices’],
while simultaneously allowing its retail clients to purchase and
institutional knowledge,” also fails.
The complaint does not
identify what material, nonpublic information was possessed by which
Warburg employee at what time. Nor does it identify any trades with
particularity with the possible exception of its settlement of
September 2001 with the specific information on which Warburg
supposedly traded in order to persuade Warburg to extend the equity
forwards, Warburg did not violate Rule 10b-5 under either the
misappropriation or classical theories of insider trading.
Under the classical theory of insider trading, a
corporate insider violates § 10(b) and Rule 10b-5 when he trades
in the securities of his own corporation based on material,
nonpublic information, i.e., conduct which constitutes a “deceptive
device” under the statute because there is a relationship of trust
and confidence between the shareholders of a corporation and those
insiders who have gained confidential information because of their
position within the corporation. Id. at 651-52. That relationship
gives rise to a duty either to disclose or to abstain from trading
to prevent the corporate insider from taking advantage of the
unknowing stockholders. Id. at 652.
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misappropriation because, as Defendants point out, Warburg sold its
hedge shares after Enron and Warburg settled the equity derivative
contracts; thus Warburg did not deceive Enron by selling stock held
to hedge transactions which Enron knew were concluded.
classical theory of insider trading apply.
Nor did the
underwriters, accountants, lawyers or consultants, “may become
temporary fiduciaries to shareholders by entering into a special
confidential relationship in the conduct of the business of the
corporate purposes” and thus also have a duty “to forgo actions
based on material, nonpublic information.”
U.S. 646, 655 & n.14 (1983).
Dirks v. S.E.C., 463
“[C]ounterparties to a bilateral
derivatives trade--where one party’s gain is the other’s loss--do
not have a ‘special confidential relationship.’” #126 at 36, citing
#122 ¶ 119.
Even if Warburg did assume a duty to assist Enron in
the “conduct of the business of the enterprise” by extending the
equity forward contracts, plaintiffs do not plead any reason why
Under the misappropriation theory, a person who is a
corporate outsider violates the statute and the rule by committing
fraud in connection with a securities transaction when he
misappropriates confidential information to trade in securities
in breach of a duty owed to the source of the information. In
other words, “a fiduciary’s undisclosed, self-serving use of a
principal’s information to purchase or sell securities in breach
of a duty of loyalty and confidentiality, defrauds the principal
of the exclusive use of that information.” Id.
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that duty would survive the termination of the
contracts, only after which did Warburg sell its hedge shares. #122
At most, again Plaintiffs charge Warburg with aiding and
abetting Enron’s fraud.
Defendants also argue that PW’s failure to provide its
retail customers with information about Enron’s “true” financial
condition does not qualify as securities fraud. PW’s only agreement
with Enron was to administer Enron’s employee stock option plan.
concealing anything or that the administration of the plan gave PW
any knowledge of Enron’s actual financial condition.
Plaintiffs plead a secret “gentleman’s agreement between PW and
Enron that barred PW brokers from advising its customers to sell or
to say anything negative about Enron. Plaintiffs provide no details
of the agreement or how it defrauded those PW clients who held Enron
stock in their PW accounts.
Moreover a party is not a primary violator if it only
engaged in routine business transactions or failed to disclose
another party’s fraud if it had no duty to do so.
Newby, # 4735 at
Plaintiffs do not claim that PW participated in any
In their response to UBS’s argument that there is no
basis for a strong inference that UBS acted with scienter, #148 at
pp. 20-21, Plaintiffs insist that UBS’s undertaking of these
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banking or other transactions employed by Enron to hide its actual
financial state or that it used the employee stock option plan to
Even it had, such claims would only be for
aiding and abetting.
Defendants also maintain that PW had no duty to disclose
material omissions to retail clients and participants in the Enron
stock option plan because the clients’ brokerage accounts were
nondiscretionary and the clients retained the ability to make
investment decisions. Martinez Tapia v. Chase Manhattan Bank, N.A.,
149 F.3d 404, 412 (5th Cir. 1998)(“[W]here the investor controls a
nondiscretionary account and retains the ability to make investment
decisions, the scope of any duties owed by the broker will generally
be confined to executing the investor’s order.”); Hand v. Dean
Witter Reynolds, Inc., 889 S.W. 2d 483, 492-93 & n.5 (Tex. App.-Houston
fiduciary duty owed to the customer [holding a non-discretionary
account] is very narrow--primarily not to make unauthorized trades).
In ¶ 223 of the complaint (#122) Plaintiffs allege,
transactions, which its own (but very vaguely mentioned) banking
standards, protocols, and regulations made to be improper attempts
to achieve particular tax, legal, accounting and regulatory
treatments where conventional structures could achieve the same
alleged commercial purpose, in itself gives rise to a strong
inference of knowledge or severe recklessness.
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This is not an “analyst” case. Plaintiffs do
not sue UBS because Barone’s research was wrong
or because Morel’s research was right.
However, the manner in which UBS actively used
Barone’s Research notes, and hid Morel’s, was
part of the scheme and artifice to deceive its
Thus Plaintiffs have not asserted, but had no obligation to, that
Barone acted with scienter.
As noted, the Fifth Circuit does not
permit group pleading of securities fraud.
“‘It is not enough to
establish fraud on the part of a corporation that one corporate
officer makes a false statement that another knows to be false.
defendant corporation is deemed to have the requisite scienter for
fraud only if the individual corporate officer [accused of fraud]
has the requisite level of scienter . . . .’”
Southland, 365 F.3d
at 366, quoting In re Apple Computer, Inc. Sec. Litig., 243 F. Supp.
2d 1012, 1023 (N.D. Ca. 2002).
Plaintiffs fail to identify who
knowingly and wrongfully failed to stop Barone from publishing his
“Strong Buy” rating.
Plaintiffs assert that UBS failed to disclose to PW
customers’ conflicts of interest between PW’s brokerage business and
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conflicted internal business practices caused Enron to collapse nor
facts showing scienter regarding any omissions involving Enron’s
Nor does the complaint provide facts giving rise to a
allegedly known to Warburg bankers.
The complaint references a
conversation between Warburg banker Jim Hunt and PW branch manager
Pat Mendenhall on August 24, 2001 about Wu, three days after Wu was
#122 ¶¶ 93-94, 102, 110.71
There is no allegation that they
discussed Enron’s financial status.
There is a vague allegation
that an outside consultant, Craig Ellis, once used the phrase, “cook
the books Enron,” during a meeting of PW brokers, but the statement
does not give rise to a strong inference that any PW employee knew
any specific facts about Enron’s financial condition.
#122 ¶ 81.
There is no assertion that this consultant ever told any PW broker
For purposes of the motion to dismiss only, Defendants
concede that Wu was wrongfully fired by Pat Mendenhall solely to
curry favor with Enron’s human resources executives, but emphasize
that Plaintiffs provide no logical link between Wu’s termination
and their securities fraud claim that someone at PW knew something
about Enron’s “true” financial condition but failed to disclose
that information to PW customers despite a duty to do so. # 126
at pp. 41-42. Even though he had no duty to disclose to his nondiscretionary-account clients, Wu did disclose to them what his own
independent research found about Enron’s precarious financial
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even one fact about Enron’s finances; instead the complaint states
that Craig Ellis was “silenced.” Id. Moreover the pages addressing
publicly disclosed sales of Enron stock by Enron insiders do not
show knowledge by PW, a third party, of Enron’s risky financial
They also fail to state how many shares of Enron stock
were retained by each these insiders to allow a determination of
substantial exposure to Enron.
Newby, H-01-3624, #1269 at 18-22
(“Whether there is an unusual or suspicious pattern of insider
trading may be gauged by such factors as timing of the sales (how
close to the period’s high priced), the amount and percentage of the
seller’s holding sold, the amount of profit the insider received,
the number of other insiders selling, or a substantial change in the
volume of insider sales.
There is no per se rule for what
constitutes illicit insider trading, and each case must be decided
on its own facts.
‘[M]ere pleading of insider trading without
regard to either context or the strength of the inferences to be
drawn, is not enough.’
Context is critical to the analysis.
example, sudden and substantial trading may not be suspicious where
the seller was legally prohibited from trading during the period
before the alleged insider trading.”).
Allegations of sales of a
corporation’s stock by insiders, without more, are not sufficient
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to plead knowledge of that corporations’s financial health even by
determining whether the pleaded facts give rise to a ‘strong’
inference of scienter, the court must take into account plausible
information about Enron. Retail brokers have long been barred from
seeking material nonpublic information from another division of a
decisions; indeed they must erect Chinese Walls to prevent the flow
of information in a multi-service financial institution and stop
their employees from illegally obtaining and trading on nonpublic
As for those Plaintiffs who claim to have held their
options or Enron securities without trading during the Class Period,
under the 1934 Act they must be dismissed.
Krim, 909 F.2d at 1443
& n.7, citing Blue Chip Stamps, 421 U.S. 723.
See also Merrill
Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 79
(2006)(private remedy under section 10(b) and Rule 10b-5 is limited
by the “in connection with the purchase or sale of any security” to
purchasers and sellers of securities and does not extend to holders
- 153 -
of securities over the class period for policy reasons, including
the danger of vexatious litigation); in accord Roland v. Green, 675
F.3d 503, 511-12 (5th Cir. 2012), aff’d sub nom. Chadbourne & Parke
LLP v. Troice, 134 S.Ct. 1058 (2014)(“a fraudulent misrepresentation
or omission is not made ‘in connection with’ a purchase of sale of
a covered security unless it is material to a decision to buy or to
sell a covered security”).
Furthermore Plaintiffs fail to plead that any acts or
Pharmaceuticals, 544 U.S. at 342 (a plaintiff must prove that the
proximately caused the plaintiff’s economic loss). The complaint’s
allegations of loss causation do not distinguish between PW and
Warburg even though they are required to separately plead each act
or omission alleged to violate Rule 10b-5 as to each separate
defendant. 15 U.S.C. § 78u-4(b)(4); Southland, 365 F.3d at 364-65.
Thus they fail to allege loss causation against both entities.
Plaintiffs do not make any allegations of public disclosures of
business practices or conflicts of interest at any time while
Enron’s stock was trading nor allegations that PW’s brokerage
practices affected Enron’s stock price in any way prior to its
bankruptcy. As noted earlier, in Public Employees Retirement System
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of Mississippi, Puerto Rico Teachers Retirement System v. Amedisys,
Inc., 769 F.3d 313, 320-21 (5th Cir. 2013)(citations omitted), the
Fifth Circuit held,
To establish proximate causation, the
plaintiff must allege that when the
“relevant truth” about the fraud
began to leak out or otherwise make
its way into the market, it caused
the price of the stock to depreciate
and, thereby, proximately caused the
circumstantially by “(1) identifying
a ‘corrective disclosure’ (a release
of information that reveals to the
market the pertinent truth that was
previously concealed or obscured by
the company’s fraud); (2) showing
that the stock price dropped soon
after the corrective disclosure; and
explanations for this price drop so
that the factfinder can infer that
it is more probable than not that it
was the corrective disclosure--as
opposed to other possible depressive
factors--that caused at least a
‘substantial’ amount of the priced
Defendants observe that the complaint fails to identify any public
disclosures about PW’s business practices or conflicts of interest
at any time when Enron’s stock was trading and thus Plaintiffs fail
to plead loss causation.
Glaser v. Enzo Biochem, Inc., 464 F.3d
474, 479-80 (4th Cir. 2006)(claim was properly dismissed where the
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complaint established that the defendants alleged misrepresentations
were not revealed to the market until after the company filed
bankruptcy), cert. denied, 549 U.S. 1304 (2007); D.E.&J. Ltd.
Partnership v. Conaway, 133 Fed. Appx. 994, 1000 (6th Cir. June 10,
2005)(affirming dismissal where complaint failed to allege that
misrepresentations to the market).
Since Plaintiffs here do not
allege any drop in the price of Enron’s stock during the class
period that they claim was based on the market’s learning of PW’s
brokerage practices or conflicts of interest, their 1934 Act claims
against PW fail.
Last of all, Defendants maintain that Plaintiffs’ claims,
expressly brought on behalf of all persons who purchased or acquired
Enron employee options or acquired Enron common stock through the
exercise of such an option (#122 ¶ 16(iii), (iv)) fail to allege
that PW violated Section 11 or 12 of the 1933 Act. Defendants agree
with Plaintiffs that Enron employees did not “purchase” or “sell”
stock options received from Enron; both Sections 11 and 12 “are by
Blue Chip, 421 U.S. at 735-36; 15 U.S.C. § 77k(a)(any
person “acquiring” a security may sue under Section 11); 15 U.S.C.
§ l (any person “purchasing” a security may sue under Section 12).
- 156 -
To qualify as an underwriter of Enron employee options under Section
11, PW would have had to purchase options from Enron, “offered” or
“sold” options for Enron in connection with the distribution of
employee options by Enron.
15 U.S.C. § 77b(11).
corporation’s grant to employees of an involuntary, noncontributory
employee benefit plan, such as an employee stock option plan (17
C.F.R. § 230.405), does not constitute a “sale” under the 1933 Act,
PW cannot be liable for any losses arising out of Enron’s grants of
options to its employees.
They also agree that after the issuance
of Daniel, 439 U.S. 551 (holding that a compulsory, noncontributory
pension plan did not constitute an “investment contract” and was
therefore not a “security” within the meaning of the 1933 and 1934
Acts), the SEC’s “1980 release,” 45 F.R.
8962, made clear that for
the registration and antifraud provisions of the 1933 Act to apply,
there must be an offer or sale of a security.
It observed that
although stock bonus plans or “plans under which an employer awards
shares of its own stock to covered employees at no direct cost to
the employees,” did provide employees with a security (corporate
stock), “there is no ‘sale’ in the 1933 Act sense to employees,
since such employees do not individually bargain to contribute cash
or other tangible or definable consideration to such plans.”
at 8968. The “no-sale” doctrine applies to grants of employee stock
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options, which are a type of employee benefit plan.
See, e.g., SEC
Release No. 33-6455, Interpretive Release on Regulation D, 48 F.R.
10045 (Mar. 10, 1983) at Question 78 (“In a typical plan, the grant
of [employee stock] options will not be deemed a sale of a security
for purposes of the Securities Act.”).
Defendants point out that the Enron plans expressly
they state that “any employee” was eligible to
receive awards of Enron stock options, that “awards shall be granted
for no cash consideration or for such minimal cash consideration as
may be required under applicable law,” that no employee or other
person eligible to participate in the plan had any right to be
awarded stock options, and that grants of options could be made to
discharge Enron’s contractractual obligations or “in payment of any
benefit or remuneration payable under any compensatory plan or
Lomuscio Decl. Ex. 20 (Enron Corp. 1994 Stock Plan) at
§ 4.1 (cited at Complaint ¶¶ 230, 234), § 5.3(i) (id. at § 7.1), and
See also Lomuscio Decl. Ex. 21 (Enron Corp. 1999 Stock
Plan) at §§ 4.1, 5.3(i), 5(3)(vii), 7.1, cited at Complaint ¶¶ 230
and 233); and Ex. 22 (Enron 1991 Stock Plan at §§ 4.1, 5.4(I), 8.1,
cited at Complaint ¶ 230, 233).
In sum, because there was no
- 158 -
employees, Lampkin, Ferrell, Swiber and Nelson’s 1933 Act claims
must be dismissed.
Complaint (#122) at ¶¶ 5,7,9,10.
These claims, however, must also be dismissed because
Enron’s grant of stock options to its employees was not a registered
As noted, the 1980 Release required an offer or sale of
a security for the registration and antifraud provisions of the 1933
Act to be applicable.
The Enron Forms S-8 cited by Plaintiffs
demonstrate that they registered only Enron common stock that could
be acquired by optionees upon the exercise of their options.
Lomuscio Decl., Exs. 23, 24, 25 (Enron Corp. Forms S-8 filed Jan.
26, 2001 in connection with the 1991, 1994, and 1999 Stock Plans),
Enron’s Plan documents also state, “The Company intends to
register . . . the shares of Stock acquirable pursuant to Awards
under the Plan.”
Lomuscio Decl. Exs. 22, 20, and 21. (Enron 1991,
1994, and 1999 Stock Plans) at § 5.3(v).
The General Instructions
to Form S-8 demonstrate that the form is available for registration
of securities to be offered under any employee benefit plan,” e.g.,
“the exercise of employee benefit plan options and the subsequent
resale of the underlying securities.”
Lomuscio Decl. Ex. 26 (SEC
Form S-8, General Instructions) at § 1(a).
#126 at p. 56.
Finally Defendants insist that no named Plaintiff has
standing to assert a 1933 Act claim based on the acquisition of
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Enron stock by exercising Enron options because the complaint and
the affidavits attached to the complaint fail to state that any
named plaintiff ever exercised his stock options and acquired Enron
stock, not to mention that he or she lost money on such shares, or
to plead facts tracing those shares to any registration statement
cannot represent a class of persons who hypothetically
could bring viable 1933 Act claims.
Plaintiffs’ Response (#148; Index of Authority #149-164)
As in a similar MDL 1446 case with respect to the 1934 Act
claims against the same UBS Defendants, Giancarlo, et al., v. UBS
Financial Services, et al., H-03-4359, #175, Plaintiffs here
distinguish their claims from those in Newby by explaining that
their claims arise from UBS’s relationship to Plaintiffs as their
securities broker, as a U.S. broker-dealer, and as a member of selfregulated securities organizations, which owed Enron investors an
establishing the practices and standards of care such broker-dealers
are required to follow in connection with their retail customers.”
See Declaration of David L. Augustus (“Augustus”),
#109-123, “Attachment 1,” UBS Form F-1 Registration Statement at
42-45; id. “Attachment 2,” UBS Compliance Sales Practice Policy
Manual at pp. 215-21.
- 160 -
#148 at pp. 4-5, citing Complaint (#122) at ¶¶ 118 43-44, 117-18,
UBS also served as some Plaintiffs’ stock options plan’s
statutory underwriter and sales conduit for securities distributed
under the plans for claims under Section 11.
#122 ¶¶ 279-88.
allegedly recklessly elevated Enron’s business interests and UBS’s
own profits above its retail Enron investors’ interests, in a
conflict of interest in which UBS breached its brokerage duties to
Plaintiffs. #122 ¶¶ 119-73. UBS also planned and participated with
Enron in the five transactions identified in the complaint and other
investment banking activities, which provided UBS with the knowledge
that Enron’s public financials were misstated.
undisclosed agreements with Enron not to fulfill UBS’s duty to its
retail investor customers, who were acquiring, purchasing and/or
holding Enron securities during the Class Period (id. at ¶¶ 74-81,
111-19, and 223-24; (2) secretly allowed Enron to exercise control
over UBS’s retail operations (id. at ¶¶ 92-110); (3) did not follow
UBS’s own established protocols and procedures to protect its Enronowning
violations, of which UBS was aware (id. at ¶¶ 223-27; and (4) failed
to disclose its substantial conflict of interest when it was rapidly
minimizing its own Enron default exposure in the public securities
- 161 -
market while promoting the purchase of Enron securities to its
retail customers (id. at ¶ 187).
UBS’s actions “violated [its]
communications duties and created additional duties of care, full
disclosure, and fair dealing, arising from UBS’s own policies and
industry regulations implementing the federal securities laws.”73
#148 at p. 6.
As for the structure of UBS, although Defendants attempt
Plaintiffs argue that the complaint (#122 at ¶¶ 27, 32, 35-36, 38,
44 and 94) asserts, and the Court must accept as true for purposes
of the motion to dismiss, that UBS is an “integrated business
enterprise,” with Warburg and PW under UBS AG, as evidenced by its
business operations during the Class Period.
#148 at p. 7.
also Augustus Decl., #109, “Attachment 3,” p. 18, The Making of UBS
See GMS Group, LLC v. Benderson, 326 F.3d 75, 81-82 (2d
Cir. 2003)(Although there is no right of action for simply
violating NASD rules, violation of NASD Rules 2860(19) and 2310,
which govern the conduct of NASD members and address the
suitability of securities recommendations, are relevant for
purposes of § 10(b) unsuitability claims); Hoxworth v. Blinder,
Robinson & Co., 903 F.3d 186, 200 (3d Cir. 1990)(violations of NASD
rules may be probative in demonstrating a course of conduct
amounting to fraud); Declaration of Augustus, #109, “Attachment 2,”
at pp. 10, 12, 29-33, and 55-57. Plaintiffs ignore Fifth Circuit
cases rejecting these as independent bases for primary violations
of the securities statutes.
- 162 -
(3d ed. March 2006); Attachments 4-11; Attachment 1 at pp. 11-12.74
transactions as the Giancarlo Plaintiffs: (1) the two restructurings
of the equity forward contracts as disguised loans, not as net share
settling of existing contracts and new replacement contracts; (2)
the E-Next Generation facility, allegedly structured to keep the
facility off Enron’s balance sheet and to provide Enron with a $600
million loan in direct violation of UBS’s investment banking, tax,
legal, and accounting or regulatory protocols; (3) the Yosemite IV
prepay transactions, with Plaintiffs arguing that UBS’s issuance of
the credit linked notes and the prepay commodity forward arrangement
were not independent transactions, but interdependent pieces of a
single integrated transaction in which UBS participated, contrary
to Defendants’ claims75; and (4) the issuance of Osprey notes and
disclosures were removed from the offering memorandum (#122 at ¶
The Court notes that these publications are not subject
to the pleading requirements of the PSLRA; Plaintiffs’ complaints
To Defendants’ contention that Plaintiffs’ pleadings
about the mechanics of Yosemite IV are conclusory and vague,
Plaintiffs respond that they have alleged facts showing that UBS
knew the Yosemite structures used a circular commodity swap to give
Enron upfront cash and eliminate price risk exposure between the
parties, thus constituting a loan to Enron. #148 at p. 29, citing
Complaint, #122 at ¶¶ 156-59.
- 163 -
154), to which UBS has not offered any disagreement.
Regarding the ratings of UBS energy sector debt analyst
Stewart Morel, Plaintiffs, citing to Morel’s deposition,76 point out
that Morel published his research reports on Enron bonds for the UBS
fixed-income group, which provided them to UBS institutional clients
for investment decisions, and that Morel as well sent them directly
to UBS personnel and clients and to anyone in UBS that wanted them.
Morel’s reports were not “hidden.”
Plaintiffs claim that Rule 10b-5's requirement that a
primary violator directly or indirectly engage in a manipulative or
deceptive, nonrepresentational act, which is at the center of this
case,77 is satisfied by allegations of UBS’s continuous failure to
disclose to its retail investing clients, to whom UBS, operating as
a single, fully integrated entity comprised of Warburg, PW and their
corporate parent UBS AG, owed duties of disclosure.
of disclosure distinguish this case from Newby, as does UBS’s
institutional material knowledge (gained through participation with
Enron mainly in the five transactions) that Enron’s public financial
Augustus Decl., Ex. 30.
As opposed to Newby, in which the theory of liability
centers around allegations that various financial institutions
worked together with Enron to create a false financial appearance.
#148 at p. 35.
- 164 -
appearance was unreliable and materially misleading and that UBS
failed to act in accordance with its own established guidelines to
suspend analyst coverage and restrict sales. Complaint, #122 ¶¶ 25,
42, 52, 116-18, 173, 188-90, 226-27.
See In re Enron, 235 F. Supp.
2d at 569 n.9 (“In Santa Fe [Industries, Inc. v. Green, 430 U.S.
462, 470 (1977)] the Supreme Court defined ‘deception’ as used in
§ 10(b) as the making of a material misrepresentation or the
nondisclosure of material information in violation of a duty to
disclose. . . . Thus the statute prohibits only the making of a
manipulative or deceptive act.”). Plaintiffs agree with Defendants
that the regulatory duty of disclosure in a nondiscretionary account
is limited to executing an investor’s order, but Plaintiffs also
emphasize as a matter of law that “anyone in possession of material
inside information must either disclose it to the investing public,
or, if he is either disabled from disclosing it in order to protect
a corporate confidence, or if he chooses not to do so, must abstain
from trading in or recommending the securities concerned while such
inside information remains undisclosed.”
SEC v. Texas Gulf Coast
Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968)(en banc), cert. denied
sub nom. Coates v. SEC, 394 U.S. 976 (1969).
- 165 -
This rule applies not
[material inside] information who may not be strictly termed an
UBS had both greater access to information
concerning Enron’s financial manipulations and a special financial
advisor/client relationship with Plaintiffs that gave rise to
specific duties of disclosure, but failed to disclose material
information to its retail clients or the public at large, nor did
it abstain from trading or recommending Enron securities.
Plaintiffs also object that they have not engaged in group
pleading, but have identified specific officers of UBS who had
knowledge that Enron’s public financial statements were materially
misleading, when these officers had this knowledge, and what they
Complaint, #122 ¶¶
124, 130, 137-44, 150, 152, 157-59, 161,
164, 165, 170, 176, 179, and 187.78
Plaintiffs claim that the
The Court observes that ¶ 124 merely states, “On May
17, 1999 Fastow approached Jim Hunt with a proposition that would
allow Enron to extract value from the ‘Equity Forward] contracts
by using the UBS hedge shares . . . in the amount of the difference
between the Forward Price and the increased market value of the
shares, which was approximately $30 per share.”
As the Court
explained on pages 11-12, this is the way the contracts were
supposed to work and there was nothing deceptive or fraudulent
about them. Paragraph 130 simply names officers for UBS and Enron
on a conference call discussing the restructuring of the Equity
Forward Contracts, again a matter not innately deceptive or
illegal. The same appears to be true of the substance of all of
the listed paragraphs. At most the allegations once again amount
to aiding and abetting Enron in effectuating a fraud on investors
and the public.
- 166 -
interrelated universe of facts [that] was communicated through out
a substantially unchanged group of top UBS officers during a
relatively short period of time and eventually even made its way to
the apex of the global organization.”
#122 ¶ 176.
The core group
of UBS top executives that managed UBS’ relationship with Enron
included Jim Hunt, Kimberly Blue, Michael Collins, Karsten Berlage,
and Wendy Field. #122 ¶¶ 49-50, 130, 139-42, 150, 157-58, 161, 16365.
In addition the executive credit team composed of Bill Glass,
Bob Verna, Roger Bieri, Chris Glockler, and Steve Landowne served
as a center for information about Enron and the risk Enron posed.
#122 ¶¶ 130, 163-65, 176-77.
Scienter can be shown in part by pleading facts indicating
a defendant’s regular pattern of related and repeated conduct,
involving an appreciation by UBS of the situation and a severely
reckless failure to take action consistent with the standard of
ordinary care to address such danger.
For example, UBS mandated
that Enron pay it $375 million in cash in September and October 2001
(#122 ¶¶ 182-86), virtually immunizing itself from Enron’s creditors
in bankruptcy because in early April 2001 a UBS risk committee,
including Bill Glass, had identified Enron as one of only three
companies that UBS did “not like” (#122 ¶ 164).
transactions that closed and created credit exposure to Enron had
- 167 -
to be approved and the exposure had to be sold or hedged (#122 ¶
UBS also took steps increasingly to eliminate its credit
exposure to Enron (#122 ¶ 187).
For example in June-July 2001, UBS
issued and sold JPY (Japanese Yen) 20 billion (approximately $163
million) worth of UBS securities to a foreign investor, pursuant to
#122 ¶ 174.
If Enron filed bankruptcy or
defaulted on its payment obligations to UBS, UBS could avoid
repayment of its debt to this institutional investor. Id. UBS used
this issuance to obtain essentially a $163 million credit default
sway from the unknowing investor. Another example, in July 2001 UBS
held a cumulative face value at maturity of $261,800,000 worth of
Zero Coupon Convertible Senior Notes Due in 2011, which UBS had
Enron register for public sale; UBS then sold the notes into the
significant exposure to Enron in 2001.
UBS negotiated specific
concessions from Enron that would allow UBS to unwind its position
fully with a stock price as low as $9.93 per share and stop Enron
from offering better terms to any other bank before UBS agreed to
amend the early termination provisions of the contracts.
It ultimately managed to settle part and terminate part of
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the contracts, forcing Enron to pay the remaining balance of
$153,453,776.44 and another $22,347,457.54 on a separate entity swap
contract maturing on October 24, 2001, then sold 2.2 million shares
of Enron common stock into the market, and ended its relationship
Lampkin, Ferrell and Swiber’s 1933 Act claims against UBS
under Sections 11 and 12 are solely against PW, as a statutory
underwriter and seller. UBS makes only two arguments to support its
motion to dismiss these claims:
(1) Plaintiffs did not “purchase”
registered securities through the Enron stock plans because a
corporation’s grant to employees of an interest in an involuntary,
noncontributory employee benefit plan, such as an employee stock
option plan, does not constitute a “sale” under the 1933 Act, and
(2) the Plaintiffs lack standing to assert claims under the 1933
#126 at pp. 53-55 and n.33.
Plaintiffs contend that the “no sale” doctrine does not
apply to Enron’s employee stock option plans. See Int’l Brotherhood
of Teamsters, Chauffeurs, Warehousemen, and Helpers of America v.
Daniel, 439 U.S. 551, 570 (1979)(holding that “the Securities Acts
do not apply to a noncontributory, compulsory pension plan” because
an employee’s participation in such a plan does not involve an
“investment contract” under Section 21(1) of the Securities Act; for
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the registration and antifraud provisions of the Securities Act to
be triggered there must be an offer of sale of a “security.”79); SEC
Release No. 33-6188, Employee Benefit Plans:
Statute, 45 F.R. 8960 (Feb. 11, 1980), codified at 17 C.F.R. 231
doctrine)(available at 1980 WL 29482 (Feb. 1, 1980).80
Decl. of Augustus, Attachment 36 at p. 467.
In In re Enron Corp. Securities, Derivative & ERISA
Litigation, 284 F. Supp. 2d 511, 639-40 (S.D. Tex. 2003), since
only the purchaser or seller of securities may bring a private
action for damages under § 10(b) and Rule 10b-5, this Court
employment retirement (pension) benefit plan
constitutes as “security” within the meaning
of the Securities Act of 1933 and the
Securities Exchange Act of 1934 . . . depends
on whether the plan is “voluntary or
The S.E.C. defined a
“‘voluntary’ plan [as] ‘one in which the
employees may elect whether or not to
participate,’” while a “contributory” plan is
“one in which employees make direct payments,
usually in the form of cash or payroll
deductions, to the plan.” [The 1980 Release,
1980 WL 29482 at *6 and nn. 19, 20]. In other
words, a “noncontributory” plan would be one
contributions. The interests of employees in
an employee benefit plan “are securities only
when the employees voluntarily participate in
the plan and individually contribute thereto.”
Id. at *2, 7. On the other hand, “ . . . the
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Insisting that the “no sale” doctrine is concerned with
whether or not a particular situation involves a “security” under
the 1933 Act, Plaintiffs claim that UBS misuses the “no sale”
doctrine to argue that there is no “purchase” of a security by
noncontributory, compulsory plan.” Id. at *8,
citing [International Brotherhood, 439 U.S. at
The SEC has long taken the position
that interests in voluntary contribution
constitute investment contracts . . . .” . .
. . The SEC’s Chairman stated before the
Senate Committee on Human Resources on the
antifraud provisions of the proposed ERISA
Improvements Act of 1979 (S.209),
An employee who is given a choice
voluntary pension plan and decides
to contribute a portion of his
earnings or savings to such plan,
has clearly made an investment
decision, particularly when his
securities issued by his employer.
Id. (noting that the reasoning in
Daniel supports the view that the
employee’s interest in a voluntary,
contributory plan is an investment
This Court observes that Enron’s stock option plans were
involuntary and noncontributory. As noted earlier, after Daniel
its progeny expanded Daniel’s reasoning to all employee benefit
plans. Under that reasoning, Enron’s employees’ interests in the
Enron stock option plans were not interests in an investment
contract and thus not securities.
Moreover, as discussed
previously, the SEC’s 1980 Release changed its position to accord
with the holding in Daniel.
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Plaintiffs in connection with their 1933 Act claims.
maintain that it is undisputed that a stock option is a security.
15 U.S.C. § 77b(1). The SEC has also proclaimed that “stock options
are a separate equity security under the Exchange Act” and that
unless an exemption applies, these securities must be registered.
Therefore the entire offering and distribution process created by
the Enron Stock Plans is subject to these registration requirements,
not merely the securities offered and distributed pursuant to them.
Plaintiffs argue that the 1980 Release specifically address stock
The Commission’s belief that the registration
provisions of the 1933 Act should be applicable
to voluntary contributory plans which involve
the purchase by employees of employer stock is
supported by the legislative history of the
Act. In 1934 Congress considered and rejected
a proposed amendment to the Act that would have
exempted employee stock investment and stock
option plans from the Act’s registration
That amendment, which had been
passed by the Senate but was eliminated in
conference, was not adopted “on the ground that
the participants in employees’ stock investment
plans may be in as great need of the protection
afforded by the availability of information
concerning the issuer for which they work as
are most members of the public.
Decl. of Augustus, Attachment 36 at p. 471.
Thus the 1991, 1994,
and 1999 Enron Stock Plans fall inside the boundaries of stock
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requirements of the Securities Act. The SEC’s interpretation of the
securities laws is entitled to deference.
See generally Chevron
U.S.A., Inc. v. NRDC, Inc., 467 U.S. 837 (1984).
Plaintiffs note that UBS’ claims that the “SEC noted that
although ‘stock bonus plans,’ or ‘plans under which and employer
awards shares of its own stock to covered employees at no direct
cost to the employees,’ did provide employees with a security
(corporate stock), #126 at p. 54, ‘there is no ‘sale’ in the 1933
Act sense to employees since such employees do not individually
consideration to such plans.” Asserting that UBS tries to obfuscate
the issue by treating as equals “stock option plans” where the
interest received by the employee is itself a “security,” and other
types of employee benefit plans that involve securities but do not
involve an investment decision with regard to them.
contend that stock option plans force an employee to make an
investment decision, i.e., to exercise the option security and sell
the underlying stock, to exercise the option security and hold the
stock, or to do nothing and allow the option security to expire
unexercised. The SEC has asserted, “Employees making such decisions
should continue to be afforded the protections of the anti-fraud
provisions of the Federal Securities Law.”
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Decl. of Augustus,
Attachment 36 at 475.
Moreover, the employee has to pay Enron for
the stock when he exercises his stock option, thereby contributing
cash under the plan’s provisions.
Plaintiffs demonstrate that the Enron Stock Plan includes
provisions for when and how the exercise is to be accomplished, the
option agreement, and other issues regarding the grant and exercise
of the Enron stock option.
#148 at p. 67.
grant of Enron stock options.
It alone governs the
UBS, on the other hand, fails to
point to a separate Enron employee benefit plan governing the grant
of stock options to support its argument that options are an
independent “species of employee benefit plan.”
Plaintiffs cite Falkowski v. Imation Corp., 309 F.3d 1123,
1129-30 (2002), amended on other grounds, 320 F.3d 905 (9th Cir.
2003)(addressing the “in connection with” element of preemption
under the Securities Litigation Uniform Standards Act (“SLUSA”) and
holding that because the 1933 and 1934 Acts define the purchase or
sale of a security to include any contract to buy or sell a
security, and because it follows from Congress’ definition that if
a person contracts to sell a security, that contract is a “sale”
even if the sale is never consummated, the grant of an employee
stock option on a covered security is a sale of that covered
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security [known as the “aborted purchaser-seller doctrine]”),81 as
distribution of employee stock options. Id. at 1129 (“Both the 1933
and 1934 Acts define the purchase or sale of a security to include
any contract to buy or sell a security.”82), citing 15 U.S.C. §§
77b(a)(3), 78c(a)(13)-(14), and Blue Chip Stamps, 421 U.S. at 751.83
In Proctor v. Vishay Intertechnology, 594 F.3d 1208,
1219-20 (9th Cir. 2009), the Ninth Circuit points out that the
suggestion in Falkowski that SLUSA completely preempted state law
was abrogated by Kircher v. Putnam Funds Trust, 547 U.S. 633, 636
SLUSA “does not itself displace state law with
federal law but makes some state-law claims
nonactionable through the class action device
in federal as well as state court.” In other
words, SLUSA does not provide a federal rule
of decision in
lieu of a state one, but
instead provides a federal defense precluding
certain state law actions from going forward.
Thus, what we termed complete preemption in
pre-Kircher cases, by which we are no longer
bound on this issue . . . is actually a
federal preclusion defense, and would not fall
under the complete preemption exception to §
1331's well-pleaded complaint rule.
“The grant of an employee stock option on a covered
security is therefor a ‘sale’ of that covered security. The option
is a contractual duty to sell a security at a later date for a sum
of money should the employee choose to buy it. Whether or not the
employee ever exercises the option, it is a ‘sale’ under Congress’s
definition.” Falkowski, 309 F.3d at 1130.
The Ninth Circuit in Falkowski, 309 F.3d at 1130,
opined regarding “the SEC’s no-sale doctrine, which provides in
part that a grant of stock under an Employee Stock Ownership Plan
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Thus state law fraud claims relating to employee stock options are
(“SLUSA”) because the alleged fraud took place “in connection with
the purchase or sale of a covered security.”84
Falkowski, 309 F.3d
Plaintiffs claim that since Falkowski no other court has
returned a contrary decision; in fact courts reviewing the issue
have agreed with Falkowski.85
See also order in an enforcement
or similar stock bonus program is generally not a ‘sale’ under the
[I]t is inapplicable here. Unlike stock bonus
plans, stock option plans involve contracts to
sell stock for money at a later date (stock
that is indisputably a “security”). Whether
or not an option grant is a sale in the lay
sense, it is a sale under the securities laws
because it is a contract to sell a security
when the option is exercised. We reject the
contrary holding of In re Cendant Corp. Sec.
Litig., 76 F. Supp. 2d 539, 545 (D.N.J. 1999).
Subsequently in Kircher v. Putnam Funds Trsut, 547 U.S.
633, 636 n.1 (2006) clarified that SLUSA “does not itself displace
state law with federal law, but makes some state-law claims
nonactionable through the class action device in federal as awell
as state court.” Proctor v. Vishay Intertechnology, Inc., 584 F.3d
1208, 1219 (9th Cir. 2009); in accord Romano v. Kazacos, 609 F.3d
512, 519 n.2 (2d Cir. 2010)(“SLUSA is a preclusion, not a
preemption statute” and citing Kircher).
Defendants point out, #167 at p. 30 & n.18, that
Falkowski deals with a sale under the 1934 Act, which, unlike a
1933 Act “sale,” does not have to be “for value,” the key phrase
in the 1933 Act that does not appear in the 1934 Act. 15 U.S.C.
§§ 77b(3), 78c(a)(14); 1980 Release, 45 F.R. 8960, 8969 (“The key
elements in the [1933 Act definition of sale] from the standpoint
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action filed by the SEC, In the Matter of Google, Inc. and David C.
Drummond, Admin. Proceeding file No. 3-11795, Release No. 8523 (Jan.
13, 2005), in which the SEC stated that it does not apply the “no
Moreover, absent an exemption from registration, an
of employee benefit plans are the words ‘value’ and ‘solicitation
of an offer to buy,’ for without one or both the 1933 Act is
inapplicable.”); Blue Chip Stamps, 421 U.S. at 733 & n.5 (noting
“Congress’ separate definition and use of [the term ‘sale’] in the
1933 and 1934 Acts”).
Moreover, argue Defendants, Falkowski
erroneously states that the SEC’s “no sale” doctrine applies only
to stock bonus plans, and not to stock option plans, a contention
which is contrary to the SEC’s practice for more than twenty-five
years. See further discussion infra. Defendants insist there is
no support for Plaintiffs’ contention that a 1933 Act “sale” took
place when Enron made compulsory, noncontributory grants of options
to its employees.
As Matthew Bodie points out in Aligning Incentives with
Equity: Employee Stock Options and Rule 10b-5, 88 Iowa L. Rev.
539, 556-57 (March 2003), in three decisions in which the courts
found ESOPS to be voluntary and contributory and therefore
represented securities, there were key distinctions made that
distinguished them from Falkowski.
In Uselton v. Commercial
Lovelace Motor Freight, Inc., 940 F.2d 564 (10th Cir. 1991), the
Tenth Circuit found that the employees contributed to the plan by
forfeiting 17% of their wages and they were given a choice of
whether to participate or to continue receiving their full wages.
Id. at 575. In Hood v. Smith’s Transfer Corp., 762 F. Supp. 1274,
1290-91 (W.D. Ky. 1991), the employees were permitted to choose
whether to participate in the plan and if they did, a 15% wage
reduction would be required, which the court found constituted
contribution by the employee.
In Harris v. Republic Airlines,
Inc., Civ. A. No. 86-2147, 1988 WL 56256, *4 (D.D.C. May 19, 1988),
the employees “agreed to participate” and to contribute a wage cut
Defendants note that Google relates to Google’s failure
to comply with SEC Rule 701 and does not mention the “no sale”
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offering of stock options must be registered under the Securities
Act of 1933.
In addition to Form S-8, which registers both offer and
the sale of all securities issued to an employee benefit plan, its
statement on this form relates to securities to be offered pursuant
to an employee stock purchase, savings, or similar plan, the
registration statement is deemed to register an indeterminate amount
of interests in such plan that are separate securities and required
to be registered under the securities Act.”87
Rules 416(c) and 405
Defendants object that General Instruction F concerns
only those securities that “are required to be registered under the
Securities Act,” and they argue that the grant of stock options
under the 1933 Act is not deemed a “sale” and does not have to be
registered. See discussion infra. Furthermore the instruction
defines the number or securities deemed registered, not what
securities must be registered on Form S-8. See also 17 C.F.R. §
230.416(c)(similar language in
stock, not the options themselves, must be registered. See, e.g.,
following SEC no-action letters: Dayton Steel Foundry Co., 1971 WL
6518 at *1 (July 8, 1971)(“It is the opinion of this office, that
the company may issue the options without registration because no
sale of a security is involved in the mere option grant,” but “the
underlying common stock could not be issued unless a registration
statement was in effect at the time of exercise.”); Formation,
Inc., 1977 WL 11544 at *2 (Dec. 5, 1977)(“[W]e are of the opinion
that Formation may grant options under the Plan without
registration under the  Act since the mere issuance of such
options does not involve a sale within the meaning of Section 2(3)
of the Act. We are also of the opinion that Formation will be
required to register the underlying common shares under the Act
- 178 -
of the Securities Act also require registration of stock option
Although UBS argues that the distribution of stock options
is separate from the distribution of Enron common stock, both
distributions are part of the same plan of distribution–-the Enron
Stock Plans–-and require investment decisions by participants. The
Form S-8 registers the entire offering, both of the common stock and
the stock options issued under the plan, although there is no filing
fee associated with the stock options; therefore the employee stock
options, although not considered for purposes of the registration
initially decide whether to invest in it and if so, must pay for it.
Their stock option plans were voluntary and contributory.
Enron hide the fact that it sought to raise money through the sale
of Enron common stock to its employees through the plans.
Arguing that UBS’s contention that because Enron failed
to register its stock options by S-8 Forms, Plaintiffs lack standing
to assert a 1933 Act is incorrect, Plaintiffs insist that they have
standing to assert their 1933 Act claims as a subclass of plaintiffs
before issuing or selling any of the shares upon exercise of the
options unless at such time the issuance of such shares would be
exempt from registration.”).
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securities, and/or purchased or acquired Enron equity securities
prospectuses pursuant to the subject Enron stock option plans
identified in the complaint at ¶¶ 16, 228, and 269.
asserts that Lampkin, Ferrell, and Swiber received registered
securities pursuant to the plans during the defined class periods.
# 122 ¶¶ 5,7,9.
Regarding the claims of “holders,” Plaintiffs urge the
Court to reconsider and reject the holding in Blue Chips Stamps and
progeny that those who neither purchased nor sold Enron securities
during the class period, but merely held onto them, lack standing
to sue for securities fraud because there is no federal remedy for
holders who are the victims of a fraud by issuers, their brokers,
their analysts, their accountants and their banks.
Defendants’ Reply (#167)
Defendants object to Plaintiffs’ current argument that
PW’s status as Plaintiffs’ stockbroker and as a corporate affiliate
of Warburg somehow changes the allegations of PW’s aiding and
abetting of Enron’s fraud into a primary violation of the securities
Plaintiffs now claim that a “core group” of Warburg bankers
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learned material nonpublic information about Enron’s “true financial
condition,” that this knowledge is imputable to UBS AG, Warburg and
PW as “institutional knowledge,” that the three UBS entities owed
a duty to disclose this information to PW customers or to bar those
customers from trading Enron securities, but that to “optimize”
information or suspend the trading in Enron securities even though
to have done so would have prevented Plaintiffs’ resulting losses.
upholding what they claim is a “unique” theory.
scienter adequately under § 10(b), i.e., to “distinguish among those
they sue and enlighten each defendant as to his or her particular
role in the alleged fraud” without indulging in impermissible group
Southland, 365 F.3d at 365.
Plaintiffs assert that
knowledge purportedly held by a few officers at Warburg or UBS AG
is attributable to PW by characterizing these three legally distinct
corporations as a “single business enterprise” with “institutional
Plaintiffs fail to allege what information any Warburg
banker knew or identify even one occurrence in which any PW employee
obtained Enron-related material nonpublic information from Warburg,
Enron or anyone else.
Thus they fail to plead scienter against
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Warburg, PW and UBS AG.
Warburg’s transactions with Enron constitute aiding and abetting
Enron’s financial-statement fraud.
Plaintiffs fail to explain how
any PW brokerage practices directly affected Enron’s stock price or
to plead that Enron’s stock price declined because of any public
disclosure of PW’s dealings with Enron.
Defendants further point out that Warburg and PW had
established duties not to share information with each other because
they were required by federal law to maintain a Chinese Wall between
Moreover insider trading laws prohibited Warburg and PW from
sharing any material nonpublic information with Plaintiffs.
material, nonpublic information about Enron, Warburg and PW had a
duty to disclose it to PW’s customers is meritless.
While Plaintiffs’ omission-based fraud claims require them
to plead they were owed a fiduciary duty, Warburg did not have a
fiduciary relationship with PW’s clients, and Plaintiffs have failed
to allege facts showing that PW had one with them.
upholding a claim under §§ 11 and/or 12 of the 1933 Act based on an
employer’s award of stock options to its employees, no less against
- 182 -
a third-party administrator like PW.
Such claims are meritless and
unprecedented and should be dismissed, insist Defendants.
involving Warburg are at most claims of aiding and abetting under
the holding of Central Bank because Plaintiffs assert that these
transactions were used by Enron to falsify its financial statements.
Thus they fail to state a securities fraud claim against Warburg or
PW as primary violators.
Now Plaintiffs appear to have shifted to
a claim that these five transactions demonstrate Warburg’s knowledge
of Enron’s wrongdoing.88
As this Court indicated in its Opinion and
Order in Newby, H-01-3624, #5242 at pp. 16-17,89
[C]onclusory allegations that a defendant
designed and structured an SPE or a transaction
that was inherently deceptive will not satisfy
the pleading standards under the PSLRA and Rule
9(b). Simply calling something a “sham” or a
“pretense” or a “fiction” does not make a
Plaintiffs object that they indicated in their response
to requests for production on October 17, 2005 regarding the five
transactions detailed in the Complaint that UBS gained its
knowledge of Enron’s manipulation of its public financial
appearance, but chose not to reveal it to the market and instead
foster its relationship with Enron to achieve Tier 1 banking fees
from Enron; in other words, Plaintiffs argue that every aspect of
UBS’s relationship with Enron is part of UBS’ fraud on the market.
Decl. of Augustus, Ex. 1 at pp. 5-7. See also Complaint (#122) at
Also available as In re Enron Corp. Securities,
Derivative & “ERISA” Litig., No. MDL 1446, Civ. A. No. H-01-3624,
2006 WL 6892915, at *5 (S.D. Tex. Dec. 4, 2006).
- 183 -
Plaintiff must allege specific details that
show that a structure of the entity or a
transaction that was created by [the bank] was
inherently deceptive and that the bank used and
employed it to deceive investors, not that
subsequently used the entity improperly to cook
its books, or that [the bank] engaged in acts,
practices, or course of business that operated
as a fraud or deceit on any person in
connection with the purchase or sale of an
None of the transactions identified in the complaint
inherently deceptive about the equity forward contracts, net share
settlement, or the early termination of a financial contract.
have Plaintiffs explained how Warburg, rather than Enron or its
accountants, “used and employed” the restructurings to deceive
Nor did Plaintiffs allege that any requisite “purchase
or sale” of an Enron security involving them occurred regarding the
equity forward contracts or their restructuring.
Nor have Plaintiffs asserted that Warburg created the
Osprey structure. Warburg only participated in a follow-on offering
of Osprey debt securities.
Nothing about the Osprey notes was
“inherently deceptive,” and Warburg did not “use and employ” Osprey
to deceive investors.
Any deception came from Enron’s sales of
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accounting treatment of those sales.
Nor was there a purchase or
sale of an Enron security involving Plaintiffs with respect to the
Similarly Warburg did not create the Yosemite structure
as a whole, nor the Yosemite IV structure particularly, but merely
participated in a follow-on offering of credit-linked notes issued
by a trust.
There was nothing “inherently deceptive” about the
Warburg was not involved in the prepay part
of the Yosemite IV transaction, nor did it use and employ the prepay
to deceive investors.
Nor were Plaintiffs involved in any purchase
or sale of an Enron security regarding this offering of creditlinked notes.
Facility, the structure of which Warburg also did not create, but
along with several other banks simply extended to it a line of
There was nothing inherently deceptive about the line of
credit to construct the power plants, regardless of whether it was
recorded on the balance sheet by Enron.
employ it to deceive investors.
accounting for it.
Nor did Warburg use and
Any deception was in Enron’s
Similarly, nor did any purchase or sale of an
Enron security occur when money was lent to E-Next.
Furthermore Defendants maintain that Plaintiffs fail to
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Plaintiffs’ claim that the Court is required to
accept as true their assertion that Warburg, PW, and UBS AG function
impermissible group pleading.
Plaintiffs must identify, but have
not, a particular employee of each defendant and what he knew about
Enron, when, why that information was material or nonpublic, and
what fraudulent acts or omissions each such individual allegedly
Specifically Plaintiffs fail to allege with any particularity what
Warburg knew about Enron’s fraud.
They fail to cite any objective
support for their conclusion that the equity forward restructurings
should have been accounted for as loans or that anyone at Warburg
knew that the Yosemite prepay constituted a “$775 million direct
loan” to Enron, or that anyone thought that Enron’s accounting
treatment for a potential exposure relating to the E-Next facility
was wrong or would not be disclosed.
Plaintiffs’ vague statements
about the Osprey Note Offering and Waimea/Kahuma do not indicate
Warburg bankers’ beliefs about the timing, amount, nature, and
accounting propriety of Plaintiffs’ allegations regarding Enron’s
“ineffective accounting hedges,” “non-arm’s-length transactions,”
“accounting for certain transactions as true sales at written up
values,” and improper disclosures of debt.
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Nor do they adequately plead what PW knew about Enron’s
The emails they mention do not show a sharing of any Enron-
related nonpublic information between Warburg and PW and had nothing
to do with Enron’s financial conditions or the risks that Enron
would be unable to service its debt and therefore suffer financial
Because they have not alleged that any identified PW
employee obtained nonpublic information about Enron’s financial
condition or about Warburg of UBS AG’s credit exposure to Enron,
information that Plaintiffs have not shown they possessed.
While Plaintiffs appear to agree that Enron’s actions
caused the price of Enron stock to drop, Plaintiffs contend that
Defendants caused their losses because somehow Defendants were aware
part of Enron’s wide-ranging fraud and that it was
“foreseeable” that Plaintiffs’ losses would occur if the market
discovered Enron’s fraud. Defendants insist that because Plaintiffs
cannot show that Warburg committed a primary violation of the
securities laws by participating in a transaction that affected
Enron’s financial statements, they cannot plead loss causation
against it simply by asserting that Enron’s financial statements
Defendants have shown that Plaintiffs failed to
allege that any of PW’s brokerage practices were disclosed before
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Enron’s bankruptcy, so they could not have caused Plaintiffs’
In the same way, Plaintiffs cannot show that the failure
to reveal information that PW and/or Warburg possessed about Enron’s
financial condition caused Plaintiffs’ losses when that information
was revealed to the marketplace.
While Plaintiffs charge that Defendants failed to act
according to their own guidelines and Sales Practices Compliance
Manual to suspend coverage and restrict sales of Enron stock (“the
purported policy violations were a violation of Rule 10b-5 or caused
Furthermore, even if Plaintiffs placed Enron
stock on a restricted list, such placement would not have affected
Plaintiffs’ trading decisions because investors desiring to trade
that stock had numerous other sources for information about Enron.
Moreover, insist Defendants, Plaintiffs mischaracterize
PW’s “restricted list” policy.
The policy manual did not require
PW to “suspend analyst coverage and restrict sales” whenever the
global UBS AG organization obtained material nonpublic information
about an issuer. PW’s policy manual actually states that securities
may be placed on the Legal Restricted List “for a number of
reasons,” none of which is articulated in the part of the manual
cited by Plaintiffs.
In addition, Plaintiffs fail to attach that
- 188 -
Plaintiffs erroneously rely. These pages contain a section entitled
“The Information Barrier,” “better known as the ‘Chinese Wall’ or
the ‘Information Wall,’ between the banking side of the Firm
(Investment banking, merchant banking, capital markets banking,
syndicate, public finance, asset-backed or mortgage-backed banking,
and structuring activities), including banking, administrative, and
support employees, and the marketing side of the Firm (research,
sales, trading and Firm administration).” This section demonstrates
that the company policy did not require automatic suspension of
material nonpublic information. See #169 at pp. 35-37, Supplemental
Decl. of Lomuscio.
Instead PW marketing employees were barred from
information from any banking employee.”
Id. at 36.
Even if Plaintiffs had adequately pleaded that Warburg
employees or PW employees possessed material nonpublic information
concerning Enron and that the failure to disclose this information
caused Plaintiffs’ losses, these claims would still fail because
information with Plaintiffs, but had affirmative duties not to share
Multi-service financial institutions have a duty to prohibit
- 189 -
bankers from giving nonpublic information to other bank employees;
in fact barring such allows brokerage and research operations to
continue unimpeded by bankers’ “institutional” knowledge.
Koppers Co., Inc. v. Am. Express Co., Shearson Lehman Brothers
Holdings, Inc., Shearson Lehman Hutton, Inc., SL Merger, Inc., BNS
Partners, BNS Inc., Bright Aggregates, Inc., Beazer PLC, and Nat’l
1988)(“The Commission has rejected the view that the conflicts of
interest . . . require the prohibition of multiple roles by
securities firms. The Commission has stated that, if multiple roles
were prohibited, ‘the capital-raising capability of the industry and
its ability to serve the public would be significantly weakened.’
As stated in the 1963 Report of the Special Study of the Securities
securities industry ‘is obviously quite out of the question.’”).
If Warburg or its employees gave PW, and through PW its client
investors, material nonpublic information to allow the clients to
avoid investment losses, Warburg or its employees could themselves
have violated Rule 10b-5.
See #126 at p. 32 and 47, citing United
States v. O’Hagan, 521 U.S. 642, 652 (1997)(Rule 10b-5 bars certain
“efforts to capitalize on public information through the purchase
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stockbrokers who advise their clients to trade on inside information
violate Rule 10b-5.90
See, e.g., United States v. Chestman, 947
F.2d 551 (2d Cir. 1991)(en banc 5-4 decision), cert. denied, 503
U.S. 1004 (1992).
To preclude insider trading, broker-dealers must
establish “Chinese Wall” policies “to prevent the misuse . . . of
material, nonpublic information.”
15 U.S.C. § 78o(f).
Walls are “designed to prevent improper or unintended dissemination
of market sensitive information from one division of a multi-service
firm to another . . . ,” in particular to “isolate a firm’s
investment banking department from other departments.” NASD Notice
Procedures (June 21, 1991).
Therefore it cannot be, as Plaintiffs
assert, an “extreme departure from the standards of ordinary care”
As opined by the court in SEC v. Alexander, 160 F.
Supp. 2d 642, 650 (S.D.N.Y. 2001),
[A] person who is in possession of insider
information and discloses that information to
others can be held liable for violating
section 10(b) and Rule 10b-5 as a “tipper”
even if he or she did not trade on the inside
See Shapiro v. Merrill Lynch,
Pierce, Fenner & Smith, 495 F.2d 228, 237 (2d
Cir. 1974). “Trades by tippees are attributed
to the tipper.” Elkind v. Liggett & Myers,
Inc., 635 F.2d 156, 165 (2d Cir. 1980).
The plaintiff must also plead that the defendant tipper acted with
adequate scienter, i.e., facts giving rise to a strong inference
of fraudulent intent. Id.
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for Warburg employees to have “observed” Chinese Wall policies in
failing to provide any nonpublic material information to PW’s
Defendants argue that the complaint fails to plead with
particularity the information possessed by Warburg employees, no
less that it was material or nonpublic. “The price of impermissible
generality is that the averments will be disregarded.”
Ladies Inv. Club, 238 F.3d at 368.
Furthermore, many of the
allegedly nonpublic facts that Plaintiffs now assert that Warburg
failed to disclose were widely known and previously characterized
by Plaintiffs, themselves, as “critical red flags that should have
put Barone on notice that Enron was in serious trouble” and which
at ¶¶ 135 and 166.
Second Amended Class Action Complaint, #20
The previous complaint highlighted Barone’s
“ignor[ing] the worsening debt and credit conditions that Enron was
reporting in its public findings” (id. at ¶¶ 56, 167), “Enron’s
practice of booking its income at present value” (id. at¶ 57), and
the $20 billion in debt “associated with [Enron’s unconsolidated
partners,” disclosed in Enron’s 2000 Form 10-K (id. at ¶ 57). Since
the complaint does not plead facts suggesting that any Warburg
employee knew nonpublic information about Enron, Plaintiffs cannot
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plead where or how Warburg or “UBS” traded on any nonpublic
Plaintiffs claim that Warburg “undertook [unspecified]
trading activities to eliminate its credit exposure to Enron for its
own benefit, while in possession of . . . [unspecified] material,
non-public information [garnered from participating in various
unsavory transactions with Enron].”
#122 ¶¶ 52, 115-16, 174, 187,
They allege that Warburg traded on material nonpublic
information (i.e., the “number, amounts, and trigger prices” of
Enron’s equity forward contracts with two other banks) by amending
and settling its equity forward contracts with Enron in late 2001,
and by Warburg’s later “unwinding” of its hedge position in October
#122 ¶¶ 176-88.
Defendants argue that “full disclosure
forecloses liability under the misappropriation theory,” and because
information on which Plaintiffs claim Warburg traded to cause
Warburg to extend the equity forwards, Warburg did not violate Rule
10b-5 under either the misappropriation theory (misappropriating
confidential information for securities trading in breach of a duty
owed to the source of the information) or the classical theory
(breach of a duty of trust and confidence owed by corporate insiders
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to corporate shareholders) of insider trading.91
O’Hagan, 521 U.S.
information. At most, to the extent that Plaintiffs allege anything
with particularity, Warburg merely aided and abetted Enron’s fraud
and did not violate the 1934 Act.
Defendants also argue that PW’s alleged failure to provide
its customers with information about Enron’s “true” financial
condition is not a securities fraud claim. Plaintiffs do not assert
that the single transaction that PW participated in with Enron,
i.e., an agreement to administer Enron’s stock option plan, aided
Enron in concealing anything or that the administration of that plan
provided PW with any knowledge of Enron’s true financial condition.
Although “outsiders” like Warburg may become temporary
fiduciaries to shareholders by “enter[ing] into a special
confidential relationship in the conduct of the enterprise and
[receiving] access to information solely for corporate purposes,”
“[f]or such a duty to be imposed . . . the corporation must expect
the outsider to keep the disclosed nonpublic information
confidential, and the relationship must imply such a duty.” Dirks
v. SEC, 463 U.S. 646, 655 & n.14 (1983). Defendants assert that
counterparties to a bilateral derivatives trade, where one party’s
gain is the other’s loss (#122 at ¶ 119), do not have a “special
Even if Warburg did have a duty to
assist Enron to conduct the business of the enterprise by extending
the equity forward contracts, there is no reason to conclude that
such duty extended beyond the termination of the equity forward
contracts—-i.e., after the time Warburg sold its hedge shares.
#122 ¶ 186.
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agreement” between PW and Enron that purportedly prohibited PW from
advising its clients to sell or from saying anything negative about
#122 at ¶ 74.
Plaintiffs provide no details about the
secret agreement or how it operated to defraud clients who held
Enron stock in their PW accounts.
Thus they fail to allege a
securities fraud claim against PW.
PW is not a primary violator of the securities laws if it
only engaged in routine business transactions or failed to disclose
another party’s fraud absent a duty to do so.
There are no
allegations that PW engaged in any banking or other transactions
used by Enron to conceal its actual financial state, or that Enron
used the employee stock option plan to defraud investors.
there were, such allegations are not sufficient to make PW a primary
violator of the law. Since Plaintiffs fail to state a claim against
PW as a primary violator used by Enron to conceal its financial
state, PW had no duty to disclose its business relationship with
Enron or transactions in Enron securities, no less against Warburg
as the source of UBS’s alleged knowledge about Enron, to its retail
clients and participants in the Enron stock option plan because
their accounts were nondiscretionary.
Martinez Tapia, 149 F.3d at
412 (“[W]here the investor controls a nondiscretionary account and
retains the ability to make investment decisions, the scope of any
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duties owed by the broker will generally be confined to executing
the investor’s order.”).
The complaint conclusorily charges that UBS failed to
disclose (1) “conflicts of interests” regarding PW’s brokerage
business and its contract to administer Enron’s options plan and (2)
“questionable business practices” purportedly obtained by Warburg
bankers from transactions with Enron.
#122 at ¶¶ 25, 51, 52.
Defendants emphasize that Plaintiffs do not plead that PW’s internal
business practices caused Enron to collapse and that they fail to
allege scienter regarding any omissions involving Enron’s financial
There are no facts alleged that give rise to a strong
inference that any PW employee possessed nonpublic information about
Enron or its alleged “questionable business practices” purportedly
known to Warburg bankers. Furthermore, PW was not severely reckless
for failing to obtain nonpublic information about Enron because
retail brokers are not permitted to seek such in another division
of a financial institution to advise their clients on investments,
and broker-dealers are required by law to establish Chinese walls
financial institution from improperly trading on material nonpublic
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Defendants point out that the complaint’s allegations of
loss causation fail to distinguish between PW and Warburg despite
the fact that loss causation must be pleaded as to each act or
omission in violation of Rule 10b-5 as to each separate defendant.
15 U.S.C. § 78u-4(b)(4); Southland, 365 F.3d at 364-65.
the complaint does not identify any public disclosure of purportedly
questionable business practices or conflicts of interest or PW’s
brokerage practices affecting Enron’s stock price that proximately
caused Plaintiffs’ economic losses at any time before its bankruptcy
while Enron’s stock was still trading.
Plaintiffs’ 1934 Act claims
accordingly must a fail for this reason, too.
Defendants contend that Plaintiffs’ claims under §§ 11 and
12 of the 1933 Act fail also because Enron employees did not
“purchase or sell” stock options received from Enron,92 because
In #167 at p. 29, Defendants note that the 1933 Act
defines the term “sale” as encompassing “every contract of sale or
disposition of a security or interest in a security for value.”
15 U.S.C. § 77b(3)(emphasis added). A grant of stock options to
employees under the 1933 Act is a “sale” only if the grant is “for
Enron employees received their stock options “for no
consideration,” so the grant of them was not “for value” and did
not constitute a 1933 Act “sale.” In Bauman v. Bish, 571 F. Supp.
1054, 1064 (N.D.W. Va. 1983), the court opined,
Participation in the ESOP [employee stock
ownership plan] for employees of the proposed
company is not voluntary, and is, in a sense,
Each participant who meets
certain minimum hours of service requirements
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will have stock allocated to his or her
Thus, there is no affirmative
investment decision. More importantly, there
is no furnishing of “value” by participating
employees. See 15 U.S.C. § 77b(3). Instead
of giving up some tangible and definable
consideration, participants earn stock through
labor for the employer. The notion that the
exchange of labor will suffice to constitute
the type of investment which the Securities
Acts were intended to regulate was rejected
in Daniel, [439 U.S. at 559-561 (“An employee
compulsory pension plan by definition makes no
payment into the pension fund.
accepts employment, one of the conditions of
which is eligibility for a possible benefit on
retirement. . . . . [T]he purported investment
is a relatively insignificant
part of an
employee’s total and indivisible compensation
No portion of an employee’s
compensation other than the potential pension
benefits has any of the characteristics of a
security, yet these noninvestment interests
cannot be segregated from the possible pension
benefits. Only in the most abstract sense may
it be said that an employee “exchanges” some
portion of his labor in return for these
possible benefits. He surrenders his labor as
a whole, and in return receives a compensation
package that is substantially devoid of
aspects resembling a security. His decision
to accept and retain covered employment may
have only an attenuate relationship, if any,
to perceived investment possibilities of a
Looking at the economic
realities, it seems clear that an employee is
selling his labor primarily to obtain a
livelihood, not making an investment.”] . . .
. [T]he Court finds that the proposed ESOP is
a method of deferring income, not reducing
wages or paying for stock. See Am. Jur. 2d
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options, and because no named Plaintiff has standing to assert the
exercising Enron options.
See earlier discussion on pp. 130-33 of
this Opinion and Order.
Defendants assert that no third-party
administrator has ever been held strictly liable under §§ 11 and 12
for errors in the issue’s financial statements because no 1933 Act
“sale” occurs when a corporation grants stock options to its
employees on a compulsory, noncontributory basis.
Furthermore Defendants present a list of six no-action
letters from the SEC demonstrating that for over thirty years the
SEC has advised companies that because no 1933 Act “sale” occurs in
Pension Reform Act § 187 (1975).
In accord Register v. Cameron & Barkley Co., 467 F. Supp. 519, 533
(D.S. Ca. 2006); In re Cendant Corp. Sec. Litig., 81 F. Supp. 2d
550, 556-58 (D.N.J. 2000); Fraser v. Fiduciary Trust Co., Intern.,
No. o4 CIV 6958(RMB)(GWG), 2005 WL 6328596, at *5 (S.D.N.Y. June
23, 2005)”; In re Enron Sec. Derivative & “ERISA” Litig., 284 F.
Supp. 2d 511, 641-42 (S.D. Tex. 2003); Employee Benefits Plans,
Securities Act Release No. 33-6188, 19 S.E.C. Docket 465, 1980 WL
29482, at *15 (SEC Feb. 1, 1980)(“SEC Release No. 6188")(“there is
no ‘sale’ in the 1933 Act sense to employees, since such persons
do not individually bargain to contribute cash or other tangible
or definable consideration to such plans”). But see Foltz v. U.S.
News & World Report, Inc., 627 F. Supp. 1143, 1159-61 (D.D.C. Jan.
15, 1996)(ESOP at issue was not designed as a method of deferring
income and concluding “that a plaintiff who asserts that he would
have deferred retirement pending a hoped-for increase in the value
of his stock holding states a claim under Section 10(b)”).
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the grant of stock options to employees of a corporation, the
options do not have to be registered under the 1933 Act.
Defendants assert that the no-action letters cited by
Plaintiffs, dated after the Class Period, do not discuss the
application of the “no sale” doctrine to grants of employee stock
options, but instead relate to irrelevant questions of whether three
securities” for the purposes of Rule 701 or whether stock options
are exempt from the registration requirements of Section 12(g) of
the 1934 Act.”
Defendants represent that to be characterized as an
“underwriter” of Enron employee options for purposes of Section 11
liability, PW must have ”purchased” options from Enron, or “offered”
or “sold” options for Enron, in connection with the “distribution”
of employee options by Enron.
15 U.S.C. § 77b(1).
maintain that a corporation’s grant to employees of an interest in
an involuntary, noncontributory employee benefit plan, for example
an employee stock option plan, does not constitute a “sale” under
the 1933 Act. Therefore PW cannot be liable for any losses stemming
from Enron’s grants of options to its employees.
See 17 C.F.R. §
purchase, savings, option, bonus, appreciation, profit sharing,
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compensation contract solely for employees . . . .”).
Sections 11 and 12 of the 1933 Act are restricted by their
express terms to “purchasers or sellers of securities.”
421 U.S. at 735-36; 17 U.S.C. § 77k(a)(any person “acquiring” a
security may sue under Section 11); 15 U.S.C. § 77l (any person
“purchasing” a security may sue under Section 12). Thus to be able
to sue, PW must qualify as an “underwriter” of Enron employee
options for purposes of Section 11 liability, must have “purchased”
options from Enron, or “offered” or “sold” options for Enron, in
connection with the distribution of employee options by Enron.
U.S.C. § 77b(11).
Defendants claim that because a corporation’s
noncontributory employee benefit plan, such as an employee stock
option plan, does not constitute a “sale” under the 1933 Act, as a
matter of law PW cannot be liable for any losses stemming from
Enron’s grants of options to its employees.
17 C.F.R. § 230.405.
Defendants sum up the law this Court discussed under
In Daniel, 439 U.S. 551,93 the Supreme Court held
In Daniel, 439 U.S. at 558, the Court applied an
“economic realities” test (substance over form) from SEC v. W.J.
Howey Co., 328 U.S. 293,301 (1946), to determine “whether the
scheme involves an investment of money in a common enterprise with
profits to come solely from the efforts of others.”
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that the 1933 and 1934 Acts do not apply to a noncontributory
pension plan because such a plan is not an investment contract94
since the purported investment by the employee is a relatively
trivial part of the employee’s total and indivisible compensation
package and because given the substantial portion of the pension
court explained, 439 U.S. at 559-60, concluding that an employee’s
participation in a noncontributory, compulsory pension plan does
not constitute a “security” or an “investment contract”:
noncontributory, compulsory pension plan by
definition makes no payment into the pension
fund. He only accepts employment, one of the
conditions of which is eligibility for a
possible benefit on retirement. . . . . In
every decision of this Court recognizing the
presence of a “security” under the Securities
Acts, the person found to have been an
investor chose to give up a specific
consideration in return for a separate
financial interest with the characteristics of
a security. . . . Even in those cases where
security and nonsecurity aspects, the interest
obtained had “to a very substantial degree the
element of investment contracts . . . .” In
every case the purchaser gave up some tangible
and definable consideration in return for an
characteristics of a security.
The SEC defines an “investment contract” as “any
contract, transaction or scheme whereby a person invests money in
a common enterprise and is led to expect profits solely from the
efforts of the promoter or third party.” Denise L. Evans, J.D.,
and O. William Evans, J.D., The Complete Real Estate Encyclopedia
(The McGraw Hill Companies, Inc. 2007).
- 202 -
participating in asset earnings is too minimal to include the
transaction within the concept of “investment contract.”
Subsequently in SEC Release No. 33-6188, Employee Benefit
Plans; Interpretations of Statute, 45 F.R. 8960 (Feb. 11, 1980),
codified at 17 C.F.R. 21 (the “1980 Release”), the SEC explained
that “for the registration and antifraud provisions of the 1933 Act
to be applicable, there must be an offer or sale of a security.”
1980 Release, 45 F.R. at 8962.95
Although “stock bonus plans” or
“plans under which an employer awards shares of its own stock to
covered employees at no direct cost to the employees” do provide
employees with a security, i.e., corporate stock, “there is no
‘sale’ in the 1933 Act sense to employees since such employees did
not individually bargain to contribute cash or other tangible or
definable consideration to such plans.”
Id. at 8968.
“sale” has the same meaning for both the antifraud and registration
provisions of the 1933 Act. See 1980 Release, 45 F.R. at 8969.
also Compass Group PLC, SEC No-Action Letter, 1999 WL 311797 (May
13, 1999)(“[W]hen an employee does not give anything of value for
stock other than continuation of employment nor independently
Under Chevron U.S.A., Inc. v. NRDC, Inc., 467 U.S. 837
(1984), the SEC’s interpretation of securities laws is entitled to
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bargains for such stock, registration is not required” under the “no
Defendants observe that the “no sale” doctrine applies to
grants of employee stock options which are a type of employee
SEC Release No. 33-6455, Interpretive Release on
Regulation D, 48 F.R. 10045 (March 10, 1983), at Question 78 (“In
a typical plan, the grant of [employee stock] options will not be
deemed a sale of a security for purposes of the Securities Act.”);
Sarnoff Corp., SEC No-Action Letter, 2001 SL 811033 (July 16,
2001)(no 1933 Act registration required for grant of interests or
Millennium Pharm., Inc., SEC No-Action Letter, 1998 WL 264102 (May
21, 1998)(No 1933 Act registration required for grant of stock
options by publicly traded company based on opinion from counsel
that “the grant of such options does not constitute a ‘sale’ or
‘offer to sell’ a security”).
The terms of Enron’s Stock Option Plans evidence that
Enron’s grants of options to its employees were noncontributory,
stating that “any employee” was eligible to receive awards of Enron
consideration or for such minimal cash consideration as may be
required under applicable law,” that no employee or other person
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eligible to participate in the plan had any right to be awarded
stock options, and that grants of options could be made to discharge
Enron’s contractual obligations or “in payment of any benefit or
remuneration payable under any compensatory plan or program.”.
These documents, referenced in #122 ¶ 233, are relied on by
Plaintiffs as “prospectuses” giving rise to 1933 liability; #130,
Lomuscio Decl. Ex. 20 (Enron Corp. 1994 Stock Plan) at §§ 4.1,
5.3(I), 7.1, 5.3(vii), cited at #122 ¶¶ 230 and 233. See also #130,
Lomuscio Dec. Ex. 21 (Enron Corp. 1999 Stock Plan) at §§ 4.1,
5.3(I), 5.3(vii), 7.1, cited at #122 ¶¶ 230, 233; and Ex. 22 (Enron
Corp. 1991 Stock Plan) at §§ 4.1, 5.4(I), 8.1, cited at #122 ¶¶ 230,
In sum, because no “purchase or sale” occurred when Enron
granted stock options to its employees, all 1933 Act claims of
Plaintiffs Lampkin, Ferrell, Swiber, and Nelson must be dismissed.
#122 ¶¶ 5,7,9,10.
In addition, Defendants repeat that these claims must be
dismissed also because Enron’s Forms S-8 neither registered nor
offered Enron Stock Options, so Enron’s grant of stock options to
its employees was not a registered offering.
The Forms S-8 cited
by the complaint state they registered only the Enron common stock
that could be acquired by optionees when they exercised those
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registration statement is being filed . . . to register additional
shares of Enron Common stock for sale”) and #128 Ex. 5 (statement
by Enron General Counsel James Derrick regarding Forms S-8 “relating
to a proposed offering and sale of up to an aggregate of 10,000,000
shares . . . of Common Stock . . . of the Company which may be
issued pursuant to the Company’s [1991, 1994, or 1999] Stock
Enron’s Plan documents also state, “The Company intends
to register . . . the shares of Stock acquirable pursuant to the
Awards under the Plan.”
#130, Lomuscio Dec. Exs. 22, 20, 21 (Enron
1991, 1994, and 1999 Stock plans) at § 5.3(v).
The instructions to
Form S-8 indicate that the form is available for registration of
“securities of the registrant to be offered under any employee
benefit plan,” such as “the exercise of employee benefit plan
options and the subsequent resale of the underlying securities.”
#130, Lomuscio Ex. 26 (SEC Form S-8, General Instructions) at §
Plaintiffs has standing to bring the 1933 Acts based on the
acquisition of Enron stock by exercising their options.
complaint and Plaintiffs’ attached affidavits do not allege that any
named plaintiff ever obtained Enron stock by exercising his or her
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stock options, not to mention that he or she lost money on such
shares or asserted facts sufficient to trace those shares to any
registration statement or prospectus identified in the complaint.
Therefore Plaintiffs lack standing.
15 U.S.C. § 77k(a) (“Section
11 suit may be brought by “any person acquiring such security” to
“recover . . . damages”) and § 77l(a)(defendants are liable under
Section 12 to “the person purchasing such security . . . to recover
the consideration paid for such security . . . or for damages”).
Last, Defendants charge that Plaintiffs have not alleged
1933 Act damages, which under Sections 11 and 12 are calculated
based on the “purchase price” paid by each plaintiff for the
Rosenzweig v. Azurix Corp., 332 F.3d 854, 873 (5th Cir.
2002)(Section 11 damages are restricted to “the price at which the
security was offered to the public”); Randall v. Loftsgaarden, 478
U.S. 647, 655-56 (1986)(Section 12(2), 15 U.S.C. § 77l, “prescribes
the remedy of rescission except where the plaintiff no longer owns
the security,” in which case “the plaintiff is entitled to a return
of the consideration paid, reduced by the amount realized when he
sold the security and by an ‘income received’ on the security,” and
thus “the buyer can ‘sue for recovery of his purchase price, or for
damages not exceeding such price.’”).
Because Enron stock options
were usually granted at no cost to ordinary Enron employees and
- 207 -
because plaintiffs have not asserted that they received options
under an employment contract, there is no ”purchase price” on which
to base damages. Lomuscio Decl. Exs. 20-22 (Enron Corp. Stock Plans
for 1991, 1994, and 1999) at § 4.1 (cited in Complaint at ¶ 230 and
233)(option “awards shall be made for no cash consideration or for
such minimal consideration
as may be required under applicable
law”). Plaintiffs have not claimed that they individually bargained
calculated for the grants of options to Plaintiffs, their Section
11 and 12 claims must be dismissed for lack of legally cognizable
See. e.g., Pierce v. Morris, Civ. A. Nos. 4:03-CV-026 et
al., 2006 WL 2370343, at *4 (N.D. Tex. Aug. 16, 2006).
Plaintiffs’ Response to Defendants’ Reply (#178)
Claiming that Defendants’ reply has raised two completely
new arguments ((1) the grant of an option is not a sale “for value”
and (2) having a Chinese Wall policy on paper “forecloses” liability
for fraud), Plaintiffs argue that they should have an opportunity
to respond and then do so in this document, although they failed to
move for leave of court to do so. In its discretion, the Court will
review the unauthorized document.
Plaintiffs assert that while their claims are unique when
compared with the Newby cases’ claims, and that there are other
- 208 -
security class actions based on various wide-ranging schemes and
material omissions with similar facts (broker-dealer securities
misleading, favorable research reports, company-wide policies to
cause brokers to increase or maintain demand for a stock among its
customers, and failures to disclose known adverse information or
risks inherent in a speculative security) to the ones asserted here
that have not been dismissed.
Ignoring the mandates of the PSLRA
and the fact that they have already had several “bites at the
apple,” Plaintiffs argue that at this point the Court should be
construing the Third Amended Complaint’s allegations in a light most
favorable to them, and not focusing on the sufficiency of the
elements of Plaintiffs’ § 10(b) fraud claims.
See, e.g., Varljen
v. H.J. Myers, Inc., No. 97 Civ 6742, 1998 WL 395266, *2 (S.D.N.Y.
July 14, 1998).
The Court disagrees.
Plaintiffs point out that although UBS argued in its
motion to dismiss that the SEC staff’s “no sale” doctrine applied
inconsistently in its Response (pp. 61-79) UBS asserts that this
earlier argument is wrong.
Now UBS abandons its “no sale doctrine”
claim for a new claim that the grant of options to Enron employees
was not a “sale for value.”
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The Court finds this argument meritless. Defendants have
not abandoned application of the “no sale” doctrine, but rely on
both points, both relevant under the law, and neither of which
cancels out the other.
Regarding UBS’s defense that it should be protected from
liability because it has a Chinese Wall policy for preventing
conflicts of interest, Plaintiffs respond that Chinese Walls are
only one of a number of required mechanisms to isolate the trading
side of the firm from the banking side in order to raise such a
defense and that a firm must not only have such a policy, but must
Plaintiffs cites as a “glaring example” of UBS’s
failure to observe its Chinese Wall procedures the equity forward
securities contracts. Because these paragraphs without explanation
vaguely refer to “UBS” without recognizing any distinction between
the bank entity from broker PW, they do not address the Chinese
Thus Plaintiffs’ point is overruled.
Complaint, #122 at ¶¶
This Court finds that Defendants correctly state the law
and apply it to the numerous and detailed allegations in the Third
Amended Complaint and in response to Plaintiffs’ briefs.
discusses below a few key reasons why Defendants’ motion to dismiss
- 210 -
should be granted in all respects, but refers the parties to
Defendants’ submissions for additional reasons why Plaintiffs fail
to state a claim under the Securities statutes against PW and
UBS As A Single Entity
“Delaware public policy does not lightly disregard the
separate legal existence of corporations.”
BASF Corp. v. POSM II
Properties Partnership, L.P., C.S. No. 3608-VCS, 2009 WL 522721 *8
n.50 (Del. Ch. March 3, 2009).
“A Delaware Court will not lightly
disregard a corporation’s jural identity.
Absent sufficient cause
Gasden v. Home Pres. Co., No. Civ. A. 18888, 2004 WL
485468, at *4 (Del. Ch. Feb. 20, 2004), citing Harco Nat. Ins. Co.
1989)(“[P]ersuading a Delaware Court to disregard the corporate
entity is a difficult task.
The legal entity of a corporation will
not be disturbed until sufficient reason appears.”). To demonstrate
“alter ego” or “instrumentality” liability in order to attribute the
actions of one corporation to another, requires “a showing of total
domination or control of a showing that the corporations are so
closely intertwined that they do not merit treatment as separate
See, e.g., Vichi v. Koninklijke Phillips Electronics,
- 211 -
N.V., 63 A.3d 26, 48-49 (Del. Ch. 2012)(rejecting claim that
corporate formalities attendant to the “far-flung Philips family of
companies” should be disregarded, not withstanding Vichi’s argument
that “Philips acted and operated through a network of subsidiaries
and employed a corporate philosophy or slogan of ‘One Philips . .
. with the aim of creating a ‘company of acting parts acting as
Observing that “‘Delaware courts take the corporate form
and corporate formalities very seriously . . . [and] will disregard
the corporate form only in the ‘exceptional case,’” the Vichi court
found that “[w]hile the ‘One Phillips’ concept may reflect a
marketing program or corporate philosophy that Philips touted at
part of an effort to create a unified company, Vichi has not
presented evidence sufficient to support a reasonable inference that
it was meant to eradicate the corporate structure of Phillips N.V.
and its subsidiaries.”
62 A.3d at 49.
In accord, eCommerce
Industries, Inc. v. MWA Intelligence, Inc., 2013 WL 5621678, *27-28
(Del. Ch. Sept. 30, 2013), order entered, 2013 WL 5785961 (Del. Ch.
Oct. 25, 2013).
Although the Delaware courts usually resolve these issues
of disregarding corporate structure in the Court of Chancery based
on facts presented, since this case is for securities fraud under
the 1933 and 1934 Acts and the PSLRA and Rule 9(b), this Court finds
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that at least the pleading of some facts sufficient to make a
plausible claim that the UBS entities operated as a single entity
in defrauding them is necessary but not satisfied here.
that Plaintiffs have failed to plead facts sufficient to support
their single, fully integrated entity theory of the three UBS
entities or of just the two named UBS Defendants to satisfy
requirements under Delaware law demonstrating that the UBS entities’
corporate structures should be disregarded.
essentially demonstrate that in all aspects of the business, the two
corporations actually functioned as a single entity and should be
treated as such.”
Pearson v. Component Technology Corp., 247 F.3d
471, (3d Cir. 2001)(citing Akzona, Inc. v. E.I. Du Pont De Nemours
& Co., 607 F. Supp. 227, 237 (D. Del. 1984)(a subsidiary is an alter
ego or instrumentality of the parent when “the separate corporate
identities . . .
are a fiction and . . . the subsidiary is, in
fact, being operated as a department of the parent.”)), cert.
denied, 534 U.S. 950 (2001). See also Mobil Oil Corp. v. Linear
Films, Inc., 718 F. Supp. 260, 266 (D. Del. 1989)(“A subsidiary
corporation may be deemed the alter ego of its corporate parent
where there is a lack of attention to corporate formalities, such
as where the assets of two entities are commingled, and their
operations intertwined” or “where a corporate parent exercises
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complete domination and control over its subsidiary.”).
Plaintiffs have not pleaded facts supporting any of the
seven factors in the “single entity test” of the Third Circuit,
which includes Delaware, to justify piercing the corporate veil:
(1) gross undercapitalization of a defendant corporation for the
purposes of the corporate undertaking; (2) a failure to observe
corporate formalities; (3) the non-payment of dividends; (4) the
insolvency of the debtor corporation at the time; (5) the siphoning
of the corporation’s funds by the dominant stockholder; (6) the
nonfunctioning of other officers or directors; (7) the absence of
corporate records; and (8) the fact that the corporation is merely
a facade for the operations of the dominant stockholder(s).
720 F. Supp. 2d at 470-71, citing Pisani, 646 F.2d at 88.
no single factor justifies a decision to disregard the corporate
entity,” some combination of these factors is required and “an
overall element of injustice or unfairness must always be present
as well.” Delaware law allows a court to “pierce the corporate veil”
of a company where plaintiffs show “(1) that the parent and the
subsidiary operated as a single economic entity and (2) that an
overall element of injustice or unfairness is present.”
v. Atex, Inc., 68 F.3d 1451, 1457 (2d Cir. 1995)(applying Delaware
Plaintiffs have failed to plead facts to support the first
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element of “exclusive domination and control . . . to the point that
[the subsidiary] no longer has legal or independent significance of
capitalized, that corporation was insolvent, that dividends were
not paid nor corporate records kept, that officers and directors did
formalities, that the dominant shareholder siphoned corporate funds,
generally that the corporation simply functioned as a facade
for the dominant shareholder.
Id.; Foxmeyer Corp., 290 B.R. at
Nor have they pleaded facts that would demonstrate the
second element, fraud or injustice in the Defendants’ use of the
corporate form, outside of the underlying cause of action.
citing In re Foxmeyer Corp., 290 B.R. 229, 236 (Bankr. D. Del.
2003); Sears, Roebuck & Co. v. Sears plc, 744 F. Supp. 1297, 1305
(D. Del. 1990).
“‘To hold otherwise would render the fraud or
injustice element meaningless, and would sanction bootstrapping.’”
Foxmeyer Corp., 290 B.R. at 235.
To pierce the corporate veil, the
corporate structure must cause the fraud, the fraud or injustice
must be found in the defendants’ use of the corporate form; the
corporation must be a fraud or a sham existing only for the purpose
of serving as a vehicle for fraud.
Foxmeyer, 290 B.R. at 236(cases
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Furthermore it appears that the purpose behind Plaintiffs’
single-entity theory is to evade a federal policy and expand
liability under the 1934 Act from just Warburg to PW even though the
alleged activities of the two entities are not overlapping or
redundant (one an investment bank providing credit or loans to
Enron, the other a broker for participants in Enron’s stock option
In sum, Plaintiffs have failed to plead sufficient facts
to plead a plausible claim that Warburg and PW functioned as a
single entity to allow the Court to pierce their corporate veils.
Moreover, they have failed to plead facts distinguishing the actions
of the two corporations, as required under Southland to state claims
of securities fraud, a failure which infects a substantial portion
of the Third Amended Complaint.
Southland, 365 F.3d at 366 (Where
the defendant is a corporation, the plaintiff must plead specific
omission; “[a] defendant corporation is deemed to have the requisite
scienter for fraud only if the individual corporate officer making
the statement has the requisite level of scienter, i.e., knows the
statement is false, or at least deliberately reckless as to its
falsity, at the time he or she makes the statement.”). “‘The
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knowledge necessary to form the requisite fraudulent intent must be
possessed by at least one agent [of the corporation] and cannot be
inferred and imputed to a corporation based on disconnected facts
known by different agents.’”
Supp. 2d at 1311.
Id. at 367, quoting Gutter, 124 F.
Plaintiffs fail to allege facts showing that any
employee at Warburger disclosed any information about Enron that it
gained from working on the five financial transactions at issue to
any employee of PW.
Nor do Plaintiffs allege facts demonstrating
that the Chinese Wall between the Warburger the banker and PW the
broker was breached.
Both The 1933 and 1934 Acts
Purchasers or Sellers, But Not Holders
Plaintiffs sue both Defendants under Section 10b and Rule
10b-5, which require that an impermissible misstatement or omission
of material fact be made with scienter, on which Plaintiffs relied,
and which proximately caused them injury “in connection with the
purchase or sale of securities.”
They sue PW under section 11, 15
U.S.C. § 77k(a), as purchasers of securities whose registrations
contain false or misleading statements of material fact and under
section 12(2), 15 U.S.C. 77l(a)(2), of the 1933 Act for offering and
selling securities on the basis of misleading information in part
in order to serve its own financial interests or those of Enron.
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By their terms, both statutes are restricted to “purchasers” or
“sellers” of securities.
Blue Chip Stamps, 421 U.S. at 735-36.
“In a ‘holder’ claim, the plaintiff alleges not that the
defendant wrongfully induced the plaintiff to purchase or sell
stock, but that the defendant wrongfully induced the plaintiff to
continue holding his stock.
As a result, the plaintiff seeks
damages for the diminished value of the stock, or the value of a
misrepresentations [or omissions].” Grant Thornton, LLP v. Prospect
High Income Fund, ML CBO IV (Cayman), Ltd., 314 S.W. 3d 913, 926
(Tex. 2010), citing Newby v. Enron Corp., 490 F. Supp. 2d 784, 787
n.4 (S.D. Tex. 2007). In Blue Chip Stamps v. Manor Drug Stores, 421
U.S. 723, 734-35 (1975), the Supreme Court rejected recognition of
holder claims under the federal securities laws because they are
speculative and difficult to prove. Id., citing Blue Chip, 421 U.S.
at 73-35 (Unlike “purchasers or sellers pursuing a § 10(b) cause of
action,” who “at least seek recovery on a demonstrable number of
shares traded[,] [i]n contrast, a putative plaintiff, who neither
purchases nor sells securities but sues instead for intangible
economic injury such as loss of a noncontractual opportunity to buy
or sell, is more likely to be seeking a largely conjectural and
speculative recovery in which the number of shares involved will
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depend on the plaintiff’s subjective hypothesis.”).
The high court
further opined on the dangers of conjecture and speculation in such
“The manner in which the defendant’s violation
caused the plaintiff to fail to act could be a
result of the reading of a prospectus, . . .
but it could just as easily come as a result of
a claimed reading of information contained in
the financial page of a local newspaper.
Plaintiff’s proof would not be that he
purchased or sold stock, a fact which would be
capable of documentary verification in most
situations, but instead that he decided not to
purchase or sell stock.
uncorroborated oral evidence of many of the
crucial elements of his claim, and still be
sufficient to go to the jury. The jury would
not even have the benefit of weighing the
plaintiff’s version against the defendant’s
version, since the elements to which the
plaintiff would testify would be in many cases
defendant. The very real risk in permitting
those in respondent’s position to sue under
Rule 10b-5 is that the door will be open to
recovery of substantial damages on the part of
one who offers only his own testimony to prove
that he ever consulted a prospectus of the
issuer, that he paid any attention to it, or
that the representations contained in it
Grant Thornton, 314 S.W. 3d at 926-27, quoting Blue Chip, 421 U.S.
See also Krim, 989 F.2d at 1443 & n.7 (“It is well
established that mere retention of securities . . . does not form
the basis for a § 10(b) or Rule 10b-5 claim.”).
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In holding that
holder claims were not cognizable in federal Rule 10b-5 actions, the
Supreme Court stated that while its decision might be seen as “‘an
arbitrary restriction which unreasonably prevents some deserving
plaintiffs from recovering damages which have in fact been caused
by violations of Rule 10b-5,” that drawback “was ‘attenuated to the
extent that remedies are available to nonpurchasers and nonsellers
under state law.’”
738, 739 n.9.
Grant Thornton, at 927, quoting Blue Chip, at
Here, however, Plaintiffs have not pleaded their
holder claims under state law, but only under federal statutes.
Furthermore the Court is completely unpersuaded by Plaintiffs’
argument that it should overrule the Supreme Court’s ruling in Blue
Chip for public policy reasons. Accordingly the Court dismisses the
federal holder claims under Rule 12(b)(6).
“Purchase or Sale” Requirement
For the 1933 and 1934 Acts to apply to the Enron stock
option plans there must be a sale.
As has been discussed, under
Howey, 328 U.S. at 558, because there is no investment of money in
a common enterprise with profits to come solely from the efforts of
others, for which the plan participants expect a profit, and under
Daniel, 439 U.S. at 559-60, and its progeny and SEC Releases Nos.
33-6188, No. 33-6455, and 33-6281, because Enron’s stock option
plans are noncontributory and compulsory for its employees, as a
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matter of law there is no sale.
Moreover PW does not qualify as a statutory “underwriter”
under § 12 because PW did not “purchase” the Enron stock from Enron
that its investor clients received upon exercising their stock
options, nor did those clients “purchase” the stock from PW,
Plaintiffs have no claim under § 12(a)(2) of the 1933 Act. As noted
by Defendants, none of the Plaintiffs in the Third Amended Complaint
alleges that he or she exercised stock options to obtain Enron
For purposes of section 11(a) of the Securities Act of
1933, because neither PW nor its clients “purchased” the Enron stock
obtained by the investor clients, Plaintiffs have no claim under 15
U.S.C. § 77k(a)(5)(Any person who purchases a security, which was
subject to a registration statement containing a false statement,
may sue “every under writer with respect to such security.”).
Therefore neither § 11 or 12 of the 1933 Act applies, and
Plaintiffs fail to state a claim under them.
Controlling Person Liability
Because Plaintiffs have failed to state a claim of a
primary violation of either the 1933 or 1934 Act, any derivative
claims they have asserted for controlling person liability also
In re BP p.l.c. Litig., 843 F. Supp. at 750, citing ABC
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Arbitrage Plaintiffs Group v. Tchuruk, 291 F.3d 336, 348 n.57 (5th
Securities Exchange Act of 1934
Primary Violations vs. Aiding and Abetting
Even if there had been a sale, as noted, the United States
Supreme Court has rejected the scheme liability theory under §
There is no private right of action under § 10(b) of the
Exchange Act for aiding and abetting.
Stoneridge, 552 U.S. at 155,
citing Central Bank of Denver, 511 U.S. at 191 (§ 10(b) does not
extend to aider and abettors).
A defendant must satisfy the
a primary violation to be liable under § 10(b),
misstatement or a failure to disclose by one with a duty to
Regents of University of California v. Credit Suisse
First Boston (USA), Inc., 482 F.3d 372, 388 (5th Cir. 2007), cert.
denied sub nom. Regents of University of California v. Merrill
Lynch, Pierce, Fenner & Smith, 552 U.S. 1170 (2008). A device, such
as a scheme, is not deceptive within the statute’s meaning “unless
it involves breach of some duty of candid disclosure owed to
investors; otherwise the defendant merely aided and abetted the
fraud by Enron.
Id. at 383.
As discussed, neither Warburg nor PW
made a public statement, nor did either have a duty to disclose
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material information to Plaintiffs.
Thus their various acts and
transactions with Enron constituted mere aiding and abetting of
fraud by Enron, which used the transactions to misrepresent its
financial condition by fraudulent or off-balance sheet accounting
in a primary violation of the 1934 Act.
Although conduct can be
deceptive and give rise liability when it has “the requisite
relation to the investors’ harm,” because reliance by a plaintiff
on a defendant’s deceptive acts is a central element of a § 10(b)
private cause of action, Warburg and PW’s actions with Enron were
not disclosed to the investing public and were too remote to satisfy
the element of reliance.
Stoneridge, 552 U.S. at 159.
participated with scienter in five transactions with Enron, it was
Enron (and its accountants and lawyers), not Warburg or PW, as the
transactions to “cook its books,” creating its allegedly fraudulent
financial statements, stock registrations and other documents filed
with the SEC, i.e., making misrepresentations of material fact, and
thereby manipulating its public financial image to defraud the
PW’s Broker Dealer Relationship to Plaintiffs and A Duty to
Disclose Under the 1934 Act
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Even if Plaintiffs had established a sale, no named
Plaintiff alleges that he had a discretionary account with PW and
therefore PW’s duty its client investors was restricted to executing
the investor’s order.
F.3d at 412.
Romano, 834 F.2d at 530; Martinez Tapia, 149
Plaintiffs have not alleged that PW failed to execute
their orders as directed.
Thus there is no basis for their § 10(b)
and Rule 10b-5 claims against PW.
Moreover, as pointed out by Defendants, there are no
factual allegations showing a direct relationship of Plaintiffs to
Warburg or UBS AG, which were not parties to the contract between
Enron and PW to administer Enron’s stock option plans and which did
not serve as brokers for PW’s retail investor clients, nor in any
fiduciary capacity of trust and confidence which would require
Warburg and/or UBS AG to disclose any nonpublic information it may
have discovered regarding any fraud by Enron.
Furthermore, as delineated in great detail by Defendants,
PW and Warburg were barred by federally required Chinese Walls from
sharing any information acquired by Warburg in its capacity as an
investment bank from its dealings with Enron on the five fraudulent
transactions at issue.
Plaintiffs have failed to allege with the
required specificity any exchange of material information between
the entities in violation of the Chinese Wall policy.
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Heightened Pleading Standards
Plaintiffs fail to satisfy the PSLRA’s heightened pleading
standards by specifying exactly what nonpublic, material information
the UBS entities knew about Enron, who discovered it, when, how, and
under what circumstances and why it was fraudulent.
Even if there had been a “sale,” Plaintiffs fail to allege
facts establishing that Defendant corporations had acted with
scienter. As discussed previously, the PSLRA mandates that “untrue
statements or omissions be set forth with particularity as to ‘the
defendant’ and that scienter be pleaded with regard to ‘each act or
omission’ sufficient to give ‘rise to a strong inference that the
defendant acted with the required state of mind.’”
F.3d at 364.
The PSLRA’s use of “the defendant” is reasonably
construed to mean “‘each defendant’ in multiple defendant cases.’”
Id. at 365.
Where the defendant is a corporation (as Warburg and
PW are), the plaintiff must plead specific facts giving rise to a
strong inference that a particular defendant’s employee acted with
scienter as to each alleged omission; “[a] defendant corporation is
deemed to have the requisite scienter for fraud only if the
individual corporate officer making the statement has the requisite
level of scienter, i.e., knows the statement is false, or at least
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deliberately reckless as to its falsity, at the time he or she makes
Southland, 365 F.3d at 366.
necessary to form the requisite fraudulent intent must be possessed
by at least one agent [of the corporation] and cannot be inferred
and imputed to a corporation based on disconnected facts known by
Id. at 367, quoting Gutter v. E.I. Dupont De
Nemours, 124 F. Supp. 2d 1291, 1311 (S.D. Fla. 2000); also citing
First Equity Corp. v. Standard & Poor’s Corp., 690 F. Supp. 256, 260
(S.D.N.Y. 1988)(“A corporation can be held to have a particular
state of mind only when that state of mind is possessed by a single
individual.”), aff’d, 869 F.2d 175 (2d Cir. 1989). Plaintiffs have
failed to plead scienter adequately for each Defendant.
As stated by Defendants, Plaintiffs fail to allege loss
causation against either Defendant. Dura Pharmaceuticals, 544 U.S.
Their allegations of fraudulent brokerage practices at PW
are not related to Enron’s fraudulent financial statements and
disclosed until after Enron’s stock became worthless.
conflicts of interest between PW’s role as administrator of Enron’s
stock option program and its own brokerage business before enron
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filed for bankruptcy.
Leaving aside Plaintiffs’ failure to specify the material,
nonpublic information that any particular Warburg employee gleaned
from Enron during the various transactions, Plaintiffs have not
alleged any specific material misrepresentation or omission by
Warburg that caused Enron’s stock to plummet.
Nor have Plaintiffs
alleged facts plausibly showing that Warburg’s five transactions and
allegedly disguised loans were inherently fraudulent and caused
Enron to file for bankruptcy.
As noted, these transactions were
merely acts adding and abetting Enron in its subsequent fraudulent
accounting of its finances.
For the reasons stated above, the Court
(1) Plaintiffs’ opposed motion for amended scheduling order and for
additional briefing is DENIED, and its motion for a ruling is MOOT
Plaintiffs’ “holder” claims under federal law are DISMISSED
under Rule 12(b)(6) for failure to state a claim for which relief
may be granted;
(3) Defendants’ motion to dismiss (#125) is GRANTED;
(4) Since Plaintiffs have already submitted three amended complaints
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and thus had multiple “bites of the apple,” and given the age of
this litigation, Plaintiffs’ motion for leave to amend (#165) is
(5) Plaintiffs’ motion to certify class (#166) is DENIED as MOOT.
A final judgment shall issue by separate instrument.
SIGNED at Houston, Texas, this
UNITED STATES DISTRICT JUDGE
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