Corporate Governance

Stoneridge Affirmed: The Impact on Enron (Part 4)

By J. Robert Brown

So, the lurking unanswered question is the impact of Stoneridge on Credit Suisse, the 5th Circuit case that exonerated the investment banking firms in Enron.  A petition for certiorari has been filed in the case and is pending.  In Credit Suisse, the Fifth Circuit held that "'deception' within the meaning of Sec. 10(b) requires that a defendant fail to satisfy a duty to disclose material information to a plaintiff."  This statement is flatly contradicted by the opinion in Stoneridge.  We expect to see the Supreme Court send the opinion back to the 5th Circuit for review in light of the reasoning in Stoneridge.  

Credit Suisse is a different case.  Stoneridge is nothing more than a policy decision declining to "extend" the antifraud provisions to the "marketplace for goods and services."  In declining to apply the presumption of reliance built into the fraud on the market theory, the Court provided no guiding principal for distinguishing vendors from other actors that caused the false financial disclosure.  The Court was only able to say that the actions of the vendors were "an indirect chain that we find too remote for liability."  It's reminiscent of Potter Stewart's adage, "I know it when I see it."  

The opinion, in contrast, refused to absolve those in the "investment sphere."  The Court chastised the plaintiff for attempting to apply the antifraud provisions "beyond the securities markets -- the realm of financing business -- to purchase and supply contracts -- the realm of ordinary business operations."  Thus, those directly impacting the realm of financing are apparently not too remote to allow fraud on the market to apply.  

Wasn't that the role of the investment banking firms in Credit Suisse?  As the Fifth Circuit described: 

• Plaintiffs allege that defendants Credit Suisse First Boston ("Credit Suisse"), Merrill Lynch & Company, Inc. ("Merrilly Lynch"), and Barclays Bank PLC ("Barclays Bank") (collectively "the banks") entered into partnerships and transactions that allowed Enron Corporation ("Enron") to take liabilities off of its books temporarily and to book revenue from the transactions when it was actually incurring debt. The common feature of these transactions is that they allowed Enron to misstate its financial condition; there is no allegation that the banks were fiduciaries of the plaintiffs, that they improperly filed financial reports on Enron's behalf, or that they engaged in wash sales or other manipulative activities directly in the market for Enron securities.

In other words, these were not ordinary goods and services.  These transactions allegedly had only one purpose:  to hide the financial condition of Enron.  As such, they are not the type of vendors that concerned the Court in Stoneridge.  

Stoneridge, therefore, may not resolve Credit Suisse.  Nonetheless, it is hard to imagine the Fifth Circuit reversing the decision on remand.  Assuming the court reaffirms the decision, expect the Supreme Court to deny cert.  It won't have the stomach for another case in the primary/secondary liability realm for at least another decade. 

Full post as published by The Race to the Bottom on January 16, 2008 (boomark / email).