We have been examining the recent spate of cases involving primary liability under Rule 10b-5. The cases involve the extension of antifraud liability to vendors. The 9th Circuit held that vendors could be liable where the principal purpose of their business transaction was to effect a fraud. The 8th Circuit held that a third party could be liable for making a false statement or causing a false statement to be made. In application, however, the 8th Circuit did not extend the test to vendors who allegedly engaged in sham transactions aware that they would be used to commit financial fraud. The case is now pending at the US Supreme Court.

The last of the trilogy involves the appeal from the investment banking firms in Enron.  As we shall see, it goes much further than the 8th Circuit. 

The appeal was actually the granting of class certification but the reasoning goes to the merits. With the failure of Enron, plaintiffs have targeted a number of third party deep pockets, particularly investment banking firms. A number settled, with Citibank for example agreeing to pay $2 billion rather than risk the wrath of a jury. For a list of the settlements (totalling almost $7.2 billion), go here. A number of investment banking firms, however, chose not to settle and appealed the district court's decision to grant class certification. See Regents v. Credit Suisse, 482 F.3d 372 (5th Cir. 2007). 

In that case, the plaintiffs alleged that the investment banking firms entered into transactions that allowed Enron to avoid disclosing the total amount of debt outstanding.  The court gave as an example the infamous Nigerian Barge Transaction where plaintiffs allege that Enron "sold" the barges to an investment banking firm in order to book revenue after it could find no "legitimate buyer" and agreed to repurchase the barges at a profit six months later, which it did.  The plaintiffs alleged that the investment banking firms knew the reasons for these "seemingly irrational transactions".   

The court, in a 2-1 opinion, determined that primary liability was only limited to those with a duty to disclose.  In arriving at the conclusion, it did not rely on Central Bank but on Chiarella, emphasizing that there can be no fraud based upon nondisclosure "absent a duty to speak. . . . We hold that a duty to disclose under Section 10(b) does not arise from the mere possession of nonpublic market information."  445 US at 234-35.  As the court noted:  "The transactions in which the banks engaged at most aided and abetted Enron's deceit by making its misrepresentations more plausible. The banks' participation in the transactions, regardless of the purpose or effect of those transactions, did not give rise to primary liability under Section 10(b)."   

The holding is breathtakingly broad.  It means that Rule 10b-5 does not reach anyone who does not have a duty to disclose to shareholders.  Not only does that exonerate vendors and investment banks, it is hard to ascertain how accounting firms, law firms, and even many employees of the issuer itself could ever be considered primary violators under this approach.  Any third party that knowingly enabled the fraud to occur (by, for example, accepting a bribe in return for documentation of a transaction that never occurred) would not be liable. 

The court got to this remarkable place by relying on Chiarella and O'Hagan, two insider trading cases.  Chiarella, the case brought against an employee of a financial printer, did suggest that insider trading was predicated upon a duty to disclose and that the duty arose out of fiduciary obligations.  Almost before the ink was dry the Supreme Court began backing off the doctrine.  As the case in Credit Suisse,  the doctrine arguably excluded anyone outside of the issuer, such as investment banks or accounting firms.  Neither had a fiduciary obligation to shareholders and, as a result, arguably did not have a duty to disclose. 

A few years later, the Supreme Court addressed this obvious anomaly in Dirks v. SEC by inventing the doctrine of "temporary insider" and extending it to those outside the issuer.  See 463 U.S. 646, 655 n. 14 ("Under certain circumstances, such as where corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is not simply that such persons acquired nonpublic corporate information, but rather that they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes."). 

Thus, while Chiarella may suggest the need for a fiduciary duty to be charged under Rule 10b-5, the Supreme Court subsequently made it clear that such a duty extended to anyone in a confidential relationship with the issuer.  The investment banking firms in Credit Suisse likely fall within that category.  Moreover, O'Hagan applied the misappropriation theory to a lawyer employed by the bidder in a tender offer.  In other words, the duty to disclose extended outside the issuer to a law firm.  These cases if anything demonstrate a willingness on the part of the Supreme Court to extend the reach of Rule 10b-5 to those entities that have some type of confidential relationship with the issuer.  The vendors in Charter might not have that type of relationship but the investment banking firms in Credit Suisse likely do.

Second, and more importantly, O'Hagan and Chiarella involve an entirely different issue than the one confronted by the court in Credit Suisse.  As is always the case with insider trading, Chiarella and O'Hagan involve a fraud that arises where there has been no disclosure.  In other words, the need for a duty to disclose is critical (this is always the case where fraud is predicated upon silence).  Chiarella and O'Hagan are cases best understood as attempting to prevent the imposition of liability for insider trading merely as a result of the possession of material nonpublic information.  As a result, the Supreme Court conditioned liability upon both possession and a duty to disclose.  

In Credit Suisse, in contrast, someone did speak, Enron.  Enron issued false financial statements.  The case, therefore, does not turn upon a need for a duty to disclose but seeks to determine who can be liable for making the false statements.

As a matter of legal analysis, Credit Suisse is a poorly reasoned case.  It purports to draw from the cases law that is not there.   It goes far beyond the decision by the 8th Circuit, which at least captured in its test those who "cause" the false disclosure. 

The Commission has apparently opted to side with the plaintiffs in their petition for certiorari.  The Court has already decided to hear In re Charter.  If it takes Credit Suisse, the two cases will be decided by a slightly different set of justices, with the possibility (but not a likely one) of inconsistent outcomes.  I have discussed that issue here.   Primary materials on the case can be found at the DU Corporate Governance web site.