MELINDA HARMON, UNITED STATES DISTRICT JUDGE.
The above referenced putative class action alleges 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 U.S.C. § 78u-4. The 1933 Act claims are brought against UBS Financial Services, Inc. f/k/a UBS Paine Webber, Inc. ("PW") only. #122 ¶¶ 228, 269.
Plaintiffs in this action have elected to proceed independently of the complaints in the Newby and Tittle actions in MDL 1446.
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). In addition because Plaintiffs have already been permitted to file four 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.
The Court leaves aside the name-calling, subjective accusations, and denigrating remarks in the various documents it reviews and focuses on the merits of the parties' contentions.
Federal Rule of Civil Procedure 8(a) states,
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." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). If the complaint lacks facts necessary to put a defendant on notice of what conduct supports the plaintiff's claims against it, the complaint
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). The plaintiff's legal conclusions are not entitled to the same assumption. Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (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, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007); Hinojosa v. U.S. Bureau of Prisons, 506 Fed. Appx. 280, 283 (5th Cir.2013).
"While a complaint attacked by a Rule 12(b)(6) motion to dismiss does not need detailed factual allegations, ... a plaintiff's obligation to provide the `grounds' of his `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, 127 S.Ct. 1955 (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, 78 S.Ct. 99, 2 L.Ed.2d 80 (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]). "`A claim 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, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009). The plausibility standard is not akin to a "probability requirement," but asks for more than a "possibility that a defendant has acted unlawfully." Twombly, 550 U.S. at 556, 127 S.Ct. 1955. "[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, 129 S.Ct. 1937.
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., 382 B.R. 49, 57 (S.D. Tex. 2007). "A complaint lacks an `arguable
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 by resort to sources whose accuracy cannot reasonably be questioned." 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.
"`[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 introduce the exhibit as part of his motion attacking the pleading.'" Sheppard 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 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
"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 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. 2001). In a securities fraud suit, the plaintiff must plead with particularity the circumstances constituting the alleged fraud: Rule 9(b) requires the plaintiff 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 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. denied, 522 U.S. 966, 118 S.Ct. 412, 139 L.Ed.2d 315 (1997). "`In cases concerning fraudulent misrepresentation and 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).
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 defendant's motive. Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1068 (5th Cir. 1994)("Although scienter may be averred generally, case law amply demonstrates that pleading scienter requires more than a simple allegation that a defendant had fraudulent intent. To plead scienter
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-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).
Section 10(b) of the Securities Exchange Act of 1934, as amended, 15 U.S.C. § 78j(b), states in relevant part,
Pursuant to the statute, the Securities and Exchange Commission ("SEC") promulgated Rule 10b-5, 17 C.F.R. § 240.10b-5, which provides:
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) violations. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148, 157, 128 S.Ct. 761, 169 L.Ed.2d 627 (2008), citing Superintendent of Ins. of N.Y. v. Bankers Life & Casualty Co., 404 U.S. 6, 13 n.9, 92 S.Ct. 165, 30 L.Ed.2d 128 (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 material misrepresentation or omission by
Loss causation, i.e., a causal connection between the defendant's material misrepresentation or omission (or other 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 whistle blowers, or analysts question financial results, 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, Inc., 565 F.3d 228, 255 (5th Cir. 2009), citing Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005). The 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,
"Where liability is premised on a failure to disclose rather than on a misrepresentation, `positive proof of reliance
"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, 114 S.Ct. 1439, quoting Chiarella v. U.S., 445 U.S. 222, 235, 100 S.Ct. 1108, 63 L.Ed.2d 348 (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, 100 S.Ct. 1108. "Silence, absent a duty to disclose, is not misleading under Rule 10b-5." Basic, Inc. v. Levinson, 485 U.S. 224, 239 n.17, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988).
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. 128, 153-54, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1972). "To invoke the Affiliated Ute presumption of reliance on an 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 at 384. "This presumption is a judicial creature. It responds to the reality that a person cannot rely upon what he is not told." Smith v. Ayres, 845 F.2d 1360, 1363 (5th Cir. 1988). "[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, 100 S.Ct. 1108.
"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.). Nevertheless the factfinder determines whether the facts give rise to a fiduciary duty. Id.
In Kinzbach Tool Co. v. Corbett-Wallace Corp., 138 Tex. 565, 160 S.W.2d 509, 512-13 (Tex. 1942), the Texas Supreme Court wrote,
For example, because of the relationship of trust and 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, 100 S.Ct. 1108. "Trading on 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, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997), citing Chiarella, 445 U.S. at 228, 100 S.Ct. 1108. "That relationship ... 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 ... uninformed shareholders.'" O'Hagan, 521 U.S. at 652, 117 S.Ct. 2199, quoting Chiarella, 445 U.S. at 228-29, 100 S.Ct. 1108. 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 remains undisclosed. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968)(en banc)("[A]nyone in possession of material 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, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969).
An individual or entity that does not fit within the traditional definition of a corporate insider may become a "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 purposes." SEC v. Cuban, 620 F.3d 551, 554 (5th Cir. 2010), citing Dirks v. SEC, 463 U.S. 646, 655 n.13, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983). The duty to disclose or abstain from trading
Violations of Rule 10b-5(a) and (c), which prohibit "employ[ing] any device, scheme or artifice to defraud" or "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 "scheme liability." In Stoneridge (5-3), the Supreme Court 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, 128 S.Ct. 761. Justice Kennedy wrote for the majority,
Id. at 769.
In Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135, 137-38, 142, 167, 131 S.Ct. 2296, 180 L.Ed.2d 166 (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,
The PSLRA "installed both substantive and procedural controls" that were "[d]esigned to curb perceived abuses of the § 10(b) private action — nuisance filings, targeting deep-pocket defendants, vexatious discovery requests and manipulation by class action lawyers." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 320, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007). The PSLRA heightened the particularity requirements for pleading securities fraud in two ways: (1) the plaintiff must "specify each statement alleged to have been 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. § 78u-4(b)(2). Indiana Elec. Workers' Pension Trust Fund IBEW v. Shaw Group, Inc., 537 F.3d 527, 533 (5th Cir. 2008). 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, 118 S.Ct. 412, 139 L.Ed.2d 315 (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. The PSLRA mandates
"`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 available" and would have actually been significant "in the deliberations of the reasonable shareholder." Basic, Inc., 485 U.S. at 231-32, 108 S.Ct. 978; 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. Although such defendant is under no duty to disclose every fact or assumption underlying a prediction, he must disclose material, firm-specific adverse facts that affect the validity or plausibility of that prediction." 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 is granted." 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
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 aware of it,'"
"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, 127 S.Ct. 2499, 168 L.Ed.2d 179 (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, 127 S.Ct. 2499. "To determine 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 inferences.'" Id. at 323-24, 127 S.Ct. 2499. But it must be "at least as compelling as any opposing inference one could draw from the facts alleged." Id. at 324, 127 S.Ct. 2499. "[A] tie favors the plaintiff." Owens v. Jastrow, 789 F.3d 529, 536 (5th Cir. 2015), quoting Lormand v. US Unwired, Inc., 565 F.3d 228, 254 (5th Cir. 2009), citing Tellabs, 551 U.S. at 324, 127 S.Ct. 2499. "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 that standard." Lormand, 565 F.3d at 251, citing Tellabs, 551 U.S. at 322-23, 127 S.Ct. 2499. 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.
If the plaintiff fails to satisfy the pleading requirements for scienter, "the district court `shall,' on 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, 346, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005). The plaintiff must plead economic loss and loss causation, i.e., a causal connection between the material misrepresentation or omission and the loss. Id. at 341-42, 125 S.Ct. 1627. "[A]n inflated purchase price will not itself constitute or proximately cause the relevant loss." Id. at 342, 125 S.Ct. 1627. 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.
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,
"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. § 230.405. 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 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. 2004). 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.
Section 20(a) of the 1934 Act, 15 U.S.C. § 78(t)("Liability of controlling persons and persons who aid and abet"), states,
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 the allegations. 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 a misrepresentation by pleading facts that such a person 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 Abbott 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. 334 (5th Cir. 2012).
The 1933 Act, 15 U.S.C. §§ 77a et seq., governs the content of securities registration statements, which the SEC requires for the trading and dealing of stock.
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).
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,
Regarding (5), under Section 2(11), 15 U.S.C. § 77b(a)(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 undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking...." 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,
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 or defective." 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. Krim v. 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 the `total mix' of information available about the proposed investment").
Thus section 11, 15 U.S.C. § 77k(a), permits "any person acquiring such security" to sue, including after market purchasers of shares issued in a public offering,
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 at 892. 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 v. Chang, 355 F.3d 164, 169 n.4 (2d Cir. 2004).
Where grounded in negligence, Section 11 only requires notice pleading under Federal Rule of Civil Procedure 8, not the heightened standards of Federal Rule of Civil Procedure 9(b) or of the PSLRA. In re Dynegy, Inc. Sec. Litig., 339 F.Supp.2d 804, (S.D. Tex. 2004), citing Lone Star Ladies, 238 F.3d at 369 (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., 305 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. Collmer, 268 F.Supp.2d at 756 (S.D. Tex. 2003). Nevertheless, if the allegations are based in fraud, the heightened standards of Rule 9(b) apply. 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 offerors and sellers of unregistered securities" and allows purchasers to recover under Section 12(1) "regardless of whether they can show any degree of fault, negligent or intentional, on the seller's part." Swenson v. Engelstad, 626 F.2d 421, 424-25 (5th Cir. 1980). An issuer's liability to a plaintiff who buys a security issued pursuant to a registration statement with a material 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 363, 369 (5th Cir. 2001), quoting Herman & MacLean v. Huddleston, 459 U.S. 375, 382, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983). In Pinter v. Dahl, 486 U.S. 622, 644, 108 S.Ct. 2063, 100 L.Ed.2d 658 (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 purchase from the issuers but from the underwriters]: "One 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.
Defendants other than the issuer can avoid liability by pleading and proving an affirmative defense of due diligence. Id.
Section 12 restricts recovery to purchasers who purchase their shares from a seller who makes use of false or misleading statements. 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. § 77b(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, 108 S.Ct. 2063, 100 L.Ed.2d 658 (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, 108 S.Ct. 2063.
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, 108 S.Ct. 2063, citing inter alia Cady v. Murphy, 113 F.2d 988, 990 (1st Cir.)(finding a broker acting as an agent to be liable as a statutory seller), cert. denied, 311 U.S. 705, 61 S.Ct. 175, 85 S.Ct. 458 (1940). The Supreme Court went on to limit a solicitor's liability to exclude the solicitor, "merely to assist the buyer," "gratuitously urges another 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, 108 S.Ct. 2063.
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 sue either at law or in equity in any court of competent jurisdiction, to recover the consideration
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 proposed investment." Krim, 989 F.2d at 1445.
There is no liability under Section 12(a)(2) if there is no duty to disclose the allegedly false or misleading information. 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. 1993)(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 disclose).
To have standing to sue under the 1933 and 1934 Acts, a plaintiff must be either a purchaser or a seller of the securities at issue. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (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 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, 94 S.Ct. 117, 38 L.Ed.2d 53 (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 business matters, the paradigm of a security."); Yoder v. Orthomolecular Nutrition Institute, Inc., 751 F.2d 555, 558
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(a)(1) and § 78c(a)(10). 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 those who seek the use of the money of others on the premise of profits." Reves v. Ernst & Young, 494 U.S. 56, 60-61, 110 S.Ct. 945, 108 L.Ed.2d 47 (1990); SEC v. W.J. Howey Co., 328 U.S. 293, 299, 66 S.Ct. 1100, 90 S.Ct. 1244 (1946).
In Howey, the Supreme Court established a test to determine whether a financial relationship constituted an "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. Id. at 298-99, 66 S.Ct. 1100. 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, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975). In Howey the Supreme Court determined, regarding the first prong, the investment of money, that the employees covered under the defined benefit
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.
The SEC subsequently expanded Daniel beyond pension plans to all involuntary and noncontributory employee benefit plans. SEC Release No. 33-6188 (Feb. 1, 1980); SEC Release No. 33-6281 (Jan. 15, 1981).
Only an actual direct purchaser or seller of securities has standing to sue under Section 10(b) and Rule 10b-5. Blue Chip Stamps, 421 U.S. at 749-55, 95 S.Ct. 1917, ratifying Birnbaum v. Newport Steel Corp., 193 F.2d 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 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, 95 S.Ct. 1917. 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 *15
This reasoning has been applied to employee stock option plans. 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." Cendant, 81 F.Supp.2d at 557-58,
Moreover where the plan is noncontributory and involuntary, the stock awarded to employees is not required to be registered because there is no "sale" to the employees since they have not individually bargained to contribute cash or other consideration to the employee stock ownership plan. 1980 SEC Release No. 33-6188. These courts and the SEC Release grew out of Daniel's finding that these stock option employees that did not directly contribute to the plan failed to meet the "investment of money" or investment contract requirement of Howey for a sale/purchase and the SEC's "no-sale" doctrine.
Plaintiffs rely on decision by the Ninth Circuit in 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," grounded in California state law, dealt with a class action 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 1126-27. 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. Moreover, emphasizing that the Supreme Court in SEC v. Zandford, 535 U.S. 813, 122 S.Ct. 1899, 153 L.Ed.2d 1 (2002), found that § 10b "should be construed not technically and restrictively, but flexibly to effectuate its remedial purposes" and "be viewed as part of the remedial package of federal securities laws," the Ninth Circuit panel focused on the fact that "the 1933
This Court observes that Falkowski relied on a statement in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 750-51, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975): "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 `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).
Plaintiffs contend that the three Defendant UBS entities (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). PW and 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 Defendant.
As stated in the complaint, PW and Warburg are 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 Petroleum Sec. Litig., 738 F.Supp. 825, 838 (D. Del. 1990). A conclusory statement that three entities are one is not sufficient without specific facts supporting such an allegation. The separate corporate forms will not be disregarded "merely upon a showing of common management or whole ownership." Id. "A subsidiary corporation may be deemed the alter ego of its corporate parent
The Third Circuit applies a "single entity test" that considers seven factors in deciding generally whether two or more corporations operated as a single economic entity: (1) a corporation is grossly undercapitalized 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). Blair, 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 Flemming Fruit Co., 540 F.2d 681, 686-87 (4th Cir. 1976) to determine whether it was appropriate to pierce the corporate veil). "While 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 as well." 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
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." Fletcher v. 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." Id. For 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 typical factors in the general corporate veil-piercing analysis: "whether the corporation was adequately capitalized for the 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 Farms, Inc., CIV. A. No. 1131, 1989 WL 110537, at *4 (Del. Ch. Sept. 19, 1989), quoting Golden Acres, 702 F.Supp. at 1104. To satisfy the second element the plaintiff must show fraud or injustice inherent "in the defendant's use of the corporate form"; however "[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 sanction bootstrapping.'" Id. citing Mobil Oil, 718 F.Supp. at 268. 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).
At issue in this case is whether PW, in its brokerage relationship with the investor participants in the Enron Stock Option program, had a fiduciary duty to disclose material information about Enron's fraudulent activities and financial 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 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 compensation. 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." See also Rauscher Pierce Refsnes, Inc. v. Great Southwest Sav., F.A., 923 S.W.2d 112, 115 (Tex. App.-Houston [14th Dist.] 1996)("The relationship between a broker and its customer is that of principal and agent."). Under the Exchange Act, 15 U.S.C. § 78c(a)(4)(A), a broker is "any person engaged in the business of effecting 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. West 1990).
Thus while a broker owes his investor-client a fiduciary duty, that duty varies in scope with the nature of their 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, 108 S.Ct. 2846, 101 L.Ed.2d 883 (1988). The 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. Id. 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."
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,
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
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. 951, 953 (E.D. Mich. 1978), aff'd, 647 F.2d 165 (6th Cir. 1981).
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 capacity beyond that of mere order taker.... The law, 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." Hazen, "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 must "must fully disclose material facts about prospective investments ... [and] all conflicts of interests when giving advice." Id. at 716, citing SEC v. Capital Gains Research Bureau, 375 U.S. 180, 191-92, 84 S.Ct. 275, 11 L.Ed.2d 237 (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 industry." SEC v. Capital Gains Research Bureau, 375 U.S. at 186, 84 S.Ct. 275.
The Investment Advisers Act of 1940, 15 U.S.C. § 80b-2(a)(11), however, defines "investment adviser" in relevant part as follows:
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 `investment advisory services,' such services were "`solely incidental to the conduct of business as a broker dealer'" and "the Bank was not an `advisory client' of the defendants."). The 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 contracts and restitution under section 215; damages are not available. Transamerica Mortg. Advisors, Inc. v. Lewis, 444 U.S. 11, 100 S.Ct. 242, 62 L.Ed.2d 146 (1979). "`[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 18-24, 100 S.Ct. 242. 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, 84 S.Ct. 275.
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,
In the late 1930's, Congress amended the Exchange Act to authorize self-regulatory organizations for broker dealers. See, e.g., Andrew F. Tuch, The Self-Regulation of Investment Bankers, 83 Geo. Wash. L. Rev. 101, 112 & n.50 (December 2014), citing Securities Exchange Act of 1934, Pub. L. No. 73-291, 48 Stat. 8881 (codified as amended at 15 U.S.C. §§ 78a-78pp (2012)). Hazen particularly highlights the SEC and FINRA [formed in 2007 to replace the National Association of Securities Dealers ("NASD")] regulations
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 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. As a result, aggrieved individual investors must frame their securities complaints as claims under § 10(b) of the Exchange Act and Rule 10b-5. Steven D.
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 of action. 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." "Market Regulation: Broker-Dealer Regulation; Credit Rating agencies," 5 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, Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213, 105 S.Ct. 1238, 84 L.Ed.2d 158 (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. 1966), cert. denied, 385 U.S. 817, 87 S.Ct. 40, 17 L.Ed.2d 56 (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 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 thereunder." 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
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, 111 S.Ct. 762, 112 L.Ed.2d 781 (1991), 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. See also Lange v. H. Hentz & Co., 418 F.Supp. 1376 (N.D. Tex. 1976)(NASD rules are evidence of the standard of care NASD members should provide and are admissible in determining the question what 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),
Federal common law has also imposed fiduciary duties in federal securities cases. For example, because a brokerage 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. When a 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 any recommendation of a security carries with it an implicit representation that the broker has an adequate basis for the recommendation." Id. at 750-51, citing Hanly v. SEC, 415 F.2d 589, 596 (2d Cir. 1969).
As another basis for enforcing suitability, the "shingle theory" holds that the SEC and self-regulatory rules require broker-dealers 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, 64 S.Ct. 781, 88 S.Ct. 1077 (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, 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." Hazen, "Are Existing Stock Broker Standards Sufficient?," 2010 Colum. Bus. L. Rev. at 740, citing Press v. Chem. Inv.
The Texas Supreme Court has opined that "the term `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 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),
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.'" Id., quoting Lappas v. Barker, 375 S.W.2d 248, 251 (Ky. 1964). "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." Id. at 508.
In Texas, to state a claim for breach of fiduciary duty, the plaintiff must
Under Texas law the formal relationship between a broker and its customer is one of principal and agent. Rauscher Pierce Refsnes, Inc. v. Great Southwest Savings, F.A., 923 S.W.2d 112, 115 (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. West v. Touchstone, 620 S.W.2d 687, 690 (Tex. Civ. App. — Dallas 1981), citing Restatement (Second) of Agency § 1 (1958). Nevertheless that fiduciary relationship is a narrow one, starting with and restricted to the scope of the agency. Hand v. Dean Witter Reynolds, Inc., 889 S.W.2d 483, 492 (Tex. App. — Houston [14th Dist.] 1994, writ denied). 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 account, are `only to fulfill the mechanical, ministerial 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 non-discretionary account is complete and his authority ceases, when the sale or purchase is made and the receipts 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 explains,
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 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 1994, 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." Aubrey v. Barlin, 159 F.Supp.3d 752, 761 (W.D. Tex. 2016), citing Meyer v. Cathey, 167 S.W.3d 327, 331 (Tex. 2005). "[T]he fact that a business relationship has been cordial and of extended duration is not by itself evidence of a confidential relationship." 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 finder. Id. at 737-38. Texas courts do not create a fiduciary relationship lightly. Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 177 (Tex. 1997); Meyer, 167 S.W.3d at 331.
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 by its participation with Enron in creating a false public 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 clients who were purchasing, acquiring and/or holding Enron securities.
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.
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. The rapid expansion of Enron's business from natural gas pipelines to 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. #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 another firm. #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 wealth.
Furthermore to keep this money flowing, PW made a secret "gentlemen's agreement" with Enron, unknown to PW's clients, that PW financial advisors would not recommend that their retail 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 intentionally misleading. Furthermore, whenever a PW client asked his financial advisor about Enron, the financial advisor was 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,
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,
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 communicated "any adverse information about Enron to Enron employees, they would be reprimanded, sanctioned, yanked from the Enron account, or even terminated." #122 ¶ 80. Whenever someone 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.'" Id. 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. Id. ¶ 78. 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 Ellis." 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 optimistic. By March 1990, in spite of PW/UBS's "Strong Buy" recommendation for Enron stock, Wu warned his clients of Enron's "worsening condition." Meanwhile between December 2000 and March 2001 PW sold more than
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. Several of Wu's clients who were also Enron officers
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,"
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,
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 had also purchased from initial purchasers Enron Zero Coupon 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
Furthermore, UBS had approximately $390 million of notational trading exposure with Enron on the Equity Forward Contracts. The Equity Forward Contracts were derivative financial instruments whose value fluctuated with the market price of Enron stock: 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." If 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. If the 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. The contracts would be settled in two ways: (1) they could be "physically settled," meaning that UBS would deliver shares to Enron and Enron would deliver cash to UBS or vice versa; or (2) they could be "net share settled." 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 accounting principles. 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 ¶¶ 119-23. 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 and § 1032(a)
Amendments in 1999 and 2000 to the Equity Forward Contracts permitted Enron and UBS to devise a largely similar
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 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 contracts. 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. As the 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 Morel's opinions. In his analysis of Enron's public filings, Morel observed an increase in debt consistently over the period from the third quarter of 2000 until Enron went out of business. Morel knew 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
Plaintiffs allege that the ways UBS actively used Barone's 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. The 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. Even though the UBS analyst research note containing the 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, regardless of the suitability of the Enron securities for a 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 were tolerated and any advice to sell had to be characterized as for diversification purposes. Id. at 265.
Lampkin, Ferrell, and Swiber's claims under the 1933 Act's Section 12(a)(2) against PW arise out of the alleged misrepresentations and omissions identified on the restatement of the Enron financials before November 8, 2001 in Enron's formal notice, filed Form 8-K,
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
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
As noted, under Section 2(11), 15 U.S.C. § 77b(a)(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 undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking...." #122 ¶ 279. 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). The SEC 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
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 Statements. 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),
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 facts in the Registration Statements. PW offered and sold securities for
Defendants contend that Plaintiffs' Third Amended 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 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 offering
Second, Defendants maintain that Plaintiffs' claims, 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 off-balance-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 primary violation of the 1934 Act under the Supreme Court's 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 PSLRA claims. 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 general and vague. Plaintiffs do not plead specific misrepresentations or misleading omissions by either Defendant with the required "who, what, when, where, and how" of each misrepresentation or omission. Furthermore, since the two entities 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. In addition, only PW, not Warburg, had a "retail brokerage relationship" with Plaintiffs that might give rise to a duty to disclose.
Nor have Plaintiffs pleaded loss causation, Defendants charge. 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 zero.
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 options. 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 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 ownership interests in each other, throughout the complaint 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"
Defendants emphasize that in opinions in Newby, this Court detailed the legal duties owed by banks to Enron investors, like Plaintiffs here. 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. Plaintiffs fail to plead primary scheme liability against Warburg. For example, in Enron, H-01-3624, slip. op. (#4735), at 180 (S.D. Tex. 2006), this Court wrote,
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. Noting that 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." Id. The Court also rejected allegations that Deutsche Bank's underwriting of various securities violated Section 10(b) and Rule 10b-5. Id.
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 institutional buyers. 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 violation by Warburg, but they do not plead scienter with the requisite particularity. No facts are pleaded showing
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.
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. There is 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 securities associated with Citibank's Yosemite transactions. 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 Defendants. Furthermore Defendants insist such conclusory 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
Defendants point out that the amendments to the two Equity Forward Contracts between UBS and Enron occurred in mid-1999 and early 2000, long before the Class Period and before PW was 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. Defendants 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.
After explaining the two restructurings in detail, Defendants conclude that the "Complaint's factual allegations were 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. The complaint correctly states that "the value of the contracts, but not their terms, fluctuated with the market price of Enron stock." #122 ¶ 212. 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 Equal Tax Treatment of Economically Equivalent Financial Instruments: 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. Accordingly, Warburg transferred to the SPE Harrier Enron stock worth $254 million in April 2000 after the stock increased in value since June 1999; in October 2001 Enron paid Warburg $153 million after Enron's stock price fell after April 2000. #122 ¶¶ 145, 185-86. The restructurings were not disguised loans, but a form of "net 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
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. #129, Lomuscio 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 (Bankr. S.D.N.Y.) at 1 and 12.
Plaintiffs claim that Warburg knew that the E-Next 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. Defendants respond that again Plaintiffs fail to plead a primary violation of Rule 10b-5. 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 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 second. Plaintiffs do not claim that Enron used the funds for anything else, not to mention that anyone at Warburg knew about such. 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 violation." 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 Enron for its own benefit, while in possession of ... material,
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. Plaintiffs do not allege that this agreement aided Enron in concealing anything or that the administration of the plan gave PW any knowledge of Enron's actual financial condition. Instead Plaintiffs plead
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 47-49.
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 [14th Dist.] 1994, writ denied)(under Texas law "the 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,
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. A 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 options-administration contract with Enron and the nonpublic information about Enron's financial status and "questionable business practices" obtained by Warburg bankers. Defendants highlight the fact that Plaintiffs do not allege that PW's conflicted internal business practices caused Enron to collapse nor facts showing scienter
Nor does the complaint provide facts giving rise to a strong inference that any PW employer possessed nonpublic information about Enron or "questionable business practices" 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 fired. #122 ¶¶ 93-94, 102, 110.
Nor have Plaintiffs alleged facts showing that PW employees were severely reckless for not obtaining nonpublic information about Enron. Retail brokers have long been barred from seeking material nonpublic information from another division of a financial institution to assist their clients in investment 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 information.
Furthermore Plaintiffs fail to plead that any acts or omissions by Warburg or PW caused Plaintiffs' losses. Dura Pharmaceuticals, 544 U.S. at 342, 125 S.Ct. 1627 (a plaintiff must prove that the defendant's misrepresentation or other fraudulent conduct 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 of Mississippi, Puerto Rico Teachers Retirement System v. Amedisys, Inc., 769 F.3d 313, 320-21 (5th Cir. 2014)(citations omitted), the Fifth Circuit held,
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 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, 127 S.Ct. 1876, 167 L.Ed.2d 363 (2007); D.E. & J. Ltd. Partnership v. Conaway, 133 Fed.Appx. 994, 1000 (6th Cir. 2005)(affirming dismissal where complaint failed to allege that K'Mart's bankruptcy
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 their terms expressly limited to purchasers or seller of securities." Blue Chip, 421 U.S. at 735-36, 95 S.Ct. 1917; 15 U.S.C. § 77k(a)(any person "acquiring" a security may sue under Section 11); 15 U.S.C. § 1 (any person "purchasing" a security may sue under Section 12). 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(a)(11). Because a 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, 99 S.Ct. 790 (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." Id. at 8968. The "no-sale" doctrine applies to grants of employee stock 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 indicate that Enron's grants of options to employees were noncontributory: 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 contractual obligations or "in payment of any benefit or remuneration payable under any compensatory plan or program." 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 § 5.3(vii). 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),
These claims, however, must also be dismissed because Enron's grant of stock options to its employees was not a registered offering. 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), at 1. 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 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 or prospectus identified in the complaint. Thus the named Plaintiffs cannot represent a class of persons who hypothetically could bring viable 1933 Act claims.
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 self-regulated securities organizations, which owed Enron investors an admitted duty
As for the structure of UBS, although Defendants attempt to distinguish the three separate entities comprising UBS, 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. See also Augustus Decl., #109, "Attachment 3," p. 18, The Making of UBS (3d ed. March 2006); Attachments 4-11; Attachment 1 at pp. 11-12.
The Lampkin Plaintiffs challenge the same five 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' claims
Regarding the ratings of UBS energy sector debt analyst Stewart Morel, Plaintiffs, citing to Morel's deposition,
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,
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 knew. Complaint, #122 ¶¶ 124, 130, 137-44, 150, 152, 157-59, 161,
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). Subsequent transactions that closed and created credit exposure to Enron had to be approved and the exposure had to be sold or hedged (#122 ¶ 164). 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 which UBS's repayment obligations were linked to Enron creditworthiness. #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 market and reduced its exposure to Enron. #122 ¶ 175. The outstanding equity forward contracts constituted UBS's most 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. #122 ¶¶ 177-78. It ultimately managed to settle part and terminate part of the contracts, forcing Enron to pay the remaining balance of
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 Act. #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, 99 S.Ct. 790, 58 L.Ed.2d 808 (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 the registration and antifraud provisions of the Securities Act to be triggered there must be an offer of sale of a "security."
Decl. of Augustus, Attachment 36 at p. 471. Thus the 1991, 1994, and 1999 Enron Stock Plans fall inside the boundaries of stock option benefit plans that are subject to the registration 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, 104 S.Ct. 2778, 81 L.Ed.2d 694 (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 bargain to contribute cash or other tangible or definable 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. Plaintiffs 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." 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
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 security [known as the "aborted purchaser-seller doctrine]"),
In addition to Form S-8, which registers both offer and the sale of all securities issued to an employee benefit plan, its Notes to General Instruction F states, "Where a registration 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."
To fully own Enron common stock, an employee must initially decide whether to invest in it and if so, must pay for it. Their stock option plans were voluntary and contributory. Nor did 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 who purchased or acquired options to purchase Enron equity securities, and/or purchased or acquired Enron equity securities through the exercise of an option to purchase Enron equity securities, pursuant to the registration statements and/or prospectuses pursuant to the subject Enron stock option plans identified in the complaint at ¶¶ 16, 228, and 269. The complaint 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 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 laws. Plaintiffs now claim that a "core group" of Warburg bankers 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" their fees from Enron Warburg and PW did not disclose the information or suspend the trading in Enron securities even though to have done so would have prevented Plaintiffs' resulting losses. Defendants contend that Plaintiffs cannot cite a single case upholding what they claim is a "unique" theory.
Defendants maintain that Plaintiffs fail to allege scienter adequately under
Nor do Plaintiffs plead loss causation. At most, 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 them. Moreover insider trading laws prohibited Warburg and PW from sharing any material nonpublic information with Plaintiffs. For both reasons Plaintiffs' argument that because Warburg had 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.
In addition, Plaintiffs fail to cite even one case 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 a third-party administrator like PW. Such claims are meritless and unprecedented and should be dismissed, insist Defendants.
Plaintiffs' allegations about the five transactions 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.
None of the transactions identified in the complaint satisfies this standard. Plaintiffs do not plead anything inherently deceptive about the equity forward contracts, net share settlement, or the early termination of a financial contract. Nor have Plaintiffs explained how Warburg, rather than Enron or its accountants, "used and employed" the restructurings to deceive investors. 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 assets to Whitewing at allegedly noneconomic prices or the accounting treatment of those sales. Nor was there a purchase or sale of an Enron security involving Plaintiffs with respect to the Osprey notes.
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 credit-linked notes. 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 credit-linked notes.
The same is true for the E-Next Generation Credit Facility, the structure of which Warburg also did not create, but along with several other banks simply extended to it a line of credit. 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. Nor did Warburg use and employ it to deceive investors. Any deception was in Enron's accounting for it. 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 allege scienter. Plaintiffs' claim that the Court is required to accept as true their assertion that Warburg, PW, and UBS AG function as a single business enterprise is a textbook example of 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 made or failed to make. Southland, 365 F.3d at 365-66. 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
Nor do they adequately plead what PW knew about Enron's fraud. 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 collapse. 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, they cannot argue that any PW employee failed to disclose 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 of some 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 were misleading. Defendants have shown that Plaintiffs failed to allege that any of PW's brokerage practices were disclosed before Enron's bankruptcy, so they could not have caused Plaintiffs' losses. 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 restricted list policy), Plaintiffs fail to allege that PW's purported policy violations were a violation of Rule 10b-5 or caused Plaintiffs' losses. 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 part of the manual immediately following the pages on which 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
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 Warburger and PW not only had no obligation to share that information with Plaintiffs, but had affirmative duties not to share it. Multi-service financial institutions have a duty to prohibit 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. See 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 Westminster Bank PLC, 689 F.Supp. 1413, 1415-16 (W.D. Pa. 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 Markets, the total elimination of potential conflicts in the 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, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997)(Rule 10b-5 bars certain "efforts to capitalize on public information through the purchase or sale of securities."). It is well established law that stockbrokers who advise their clients to trade on inside information violate Rule 10b-5.
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." Lone Star 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 provided "objective evidence that confirmed Enron's worsening financial condition." Second Amended Class Action Complaint, #20 at ¶¶ 135 and 166. 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 plead where or how Warburg or "UBS" traded on any nonpublic information.
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, 208, 337. 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 2001. #122 ¶¶ 176-88. Defendants argue that "full disclosure forecloses liability under the misappropriation theory," and because Enron voluntarily gave Warburg in September 2001 the same 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 to corporate shareholders) of insider trading.
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. Instead they rely on the vaguely characterized "gentleman's agreement" between PW and Enron that purportedly prohibited PW from advising its clients to sell or from saying anything negative about Enron. #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. Even if 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 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) nonpublic information about Enron's financial condition and "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 condition. 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 to preclude the flow of information within a multi-service financial institution
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. Moreover 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,
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 the grant of stock options to employees of a corporation, the options do not have to be registered under the 1933 Act. #167 at pp. 31-32. 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 classes of membership units "can be considered one class of 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(a)(1). Defendants 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. § 230.405 ("The term `employee benefit plan' means any written purchase, savings, option, bonus, appreciation, profit sharing, thrift, incentive, pension, or other similar plan or written 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." Blue Chip, 421 U.S. at 735-36, 95 S.Ct. 1917; 15 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. 15 U.S.C. § 77b(a)(11). Defendants claim that because a corporation's grant to its 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, 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 "Applicable law." In Daniel, 439 U.S. 551, 99 S.Ct. 790,
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.
Defendants observe that the "no sale" doctrine applies to grants of employee stock options which are a type of employee benefit plan. 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,
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 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 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, 233.
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 options. #130, Lomuscio Decl. Exs. 23, 24, 23 at 1 ("This 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 Plan."). 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 § 1(a).
Next Defendants emphasize that none of the named Plaintiffs has standing to bring the 1933 Acts based on the acquisition of Enron stock by exercising their options. The complaint and Plaintiffs' attached affidavits do not allege that any named plaintiff ever obtained Enron stock by exercising his or her 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
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 security. Rosenzweig v. Azurix Corp., 332 F.3d 854, 873 (5th Cir. 2003)(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, 106 S.Ct. 3143, 92 L.Ed.2d 525 (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 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 for their stock options. Since 1933 Act damages cannot be calculated for the grants of options to Plaintiffs, their Section 11 and 12 claims must be dismissed for lack of legally cognizable damages. See. e.g., Pierce v. Morris, Civ. A. Nos. 4:03-CV-026, 2006 WL 2370343, at *4 (N.D. Tex. Aug. 16, 2006).
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 security class actions based on various wide-ranging schemes and material omissions with similar facts (broker-dealer securities frauds involving the inflation of stock price, creation of 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. Meyers, 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
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
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. The Court discusses below a few key reasons why Defendants' motion to dismiss 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 Warburg.
"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 the separate legal existence of a corporation will not be disturbed." Gadsden v. Home Pres. Co., No. Civ. A. 18888, 2004 WL 485468, at *4 (Del. Ch. Feb. 20, 2004), citing Harco Nat. Ins. Co. v. Green Farms, Inc., 1989 WL 110537, *4 (Del. Ch. Sept. 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 entities." See, e.g., Vichi v. Koninklijke Philips Electronics, N.V., 62 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 one.'"). 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
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 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. It finds 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. Plaintiffs "must 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, 122 S.Ct. 345, 151 L.Ed.2d 261 (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 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). Blair, 720 F.Supp.2d at 470-71, citing Pisani, 646 F.2d at 88. "While 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." Fletcher v. Atex, Inc., 68 F.3d 1451, 1457 (2d Cir. 1995) (applying Delaware law). Plaintiffs have failed to plead facts to support the first element of "exclusive domination and control ... to the point that [the subsidiary] no longer has legal or independent significance of its own," such as that the corporation was not adequately capitalized, that corporation was insolvent, that dividends were not paid nor corporate
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 plans).
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 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 deliberately reckless as to its falsity, at the time he or she makes the statement."). "`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.'" Id. at 367, quoting Gutter, 124 F.Supp.2d at 1311. 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.
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
"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 forfeited opportunity, allegedly caused by the defendants 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, 95 S.Ct. 1917, 44 L.Ed.2d 539 (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 734-35, 95 S.Ct. 1917 (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 depend on the plaintiff's subjective hypothesis."). The high court further opined on the dangers of conjecture and speculation in such a claim:
Grant Thornton, 314 S.W.3d at 926-27, quoting Blue Chip, 421 U.S. at 746, 95 S.Ct. 1917. 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."). 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.'"
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 301, 66 S.Ct. 1100, 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, 99 S.Ct. 790, 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 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 stock.
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.
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 fail. In re BP p.l.c. Litig., 843 F.Supp.2d at 750, citing ABC Arbitrage Plaintiffs Group v. Tchuruk, 291 F.3d 336, 348 n.57 (5th Cir. 2002),
Even if there had been a sale, as noted, the United States Supreme Court has rejected the scheme liability theory under § 10(b). There is no private right of action under § 10(b) of the Exchange Act for aiding and abetting. Stoneridge, 552 U.S. at 155, 128 S.Ct. 761, citing Central Bank of Denver, 511 U.S. at 191, 114 S.Ct. 1439 (§ 10(b) does not extend to aider and abettors). A defendant must satisfy the requirements for a primary violation to be liable under § 10(b), i.e., must engage in deceptive conduct involving either a misstatement or a failure to disclose by one with a duty to disclose. 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, 128 S.Ct. 1120, 169 L.Ed.2d 957 (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
While the Third Amended Complaint alleges that UBS participated with scienter in five transactions with Enron, it was Enron (and its accountants and lawyers), not Warburg or PW, as the only primary violator, that was responsible for using these 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 investing public.
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. Romano, 834 F.2d at 530; Martinez Tapia, 149 F.3d at 412. 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.
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 stated by Defendants, Plaintiffs fail to allege loss causation against either Defendant. Dura Pharmaceuticals, 544 U.S. at 342, 125 S.Ct. 1627. Their allegations of fraudulent brokerage practices at PW are not related to Enron's fraudulent financial statements and accounting. Furthermore, those brokerage practices were not disclosed until after Enron's stock became worthless. Nor do Plaintiffs allege that there was a public disclosure of the conflicts of interest between PW's role as administrator of Enron's stock option program and its own brokerage business before Enron 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
ORDERS that
(1) Plaintiffs' opposed motion for amended scheduling order and for additional briefing is DENIED, and its motion for a ruling is MOOT (# 223);
(2) 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 and thus had multiple "bites of the apple," and given the age of this litigation, Plaintiffs' motion for leave to amend (# 165) is DENIED; and
A final judgment shall issue by separate instrument.
Warburg and PW are collectively referred to as "Defendants." #122 ¶ 15. Warburg, PW and UBS AG are collectively referred to as "UBS." Id.
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 Group, Inc. v. First Derivative Traders, 564 U.S. 135, 131 S.Ct. 2296, 180 L.Ed.2d 166 (2011)(clarifying who "makes a statement"), and Halliburton Co. v. Erica P. John Fund, Inc., ___ U.S. ___, 134 S.Ct. 2398, 189 L.Ed.2d 339 (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.
In the dissent, Justice Breyer, joined by Justices Ginsburg, Sotomayor, and Kagen, opined,
Id., 564 U.S. at 149-50, 131 S.Ct. 2296.
Observing that the opinion in Int'l Brotherhood of Teamsters, Chauffeurs, Warehousemen & Helpers of America v. Daniel, 439 U.S. 551, 99 S.Ct. 790, 58 L.Ed.2d 808 (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.
Id. at 681.
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 §§ 11 and 12 1933 Act claims was from October 19, 1998 to November 19, 2001.
There are two proposed subclasses of PW customer 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), respectively).
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 Cir. 2001).
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 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 earlier-uttered 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 mistaken. 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.").
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.").
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.
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.
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 of 15%.
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.
In accord Register v. Cameron & Barkley Co., 467 F.Supp.2d 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, 1986)(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)").
