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Mayer Brown Not Liable for Losses of Refco Investors, 2nd Circuit DecidesLawsuit is one of three against the law firm that has been dismissed in the Southern District of New York; another suit is still pending
Secondary actors such as attorneys can only be held liable for false statements in private damages actions under the securities laws if the statements are attributable to them at the time they are disseminated, a federal appeals court decided Tuesday. Ruling in a civil suit brought against Mayer Brown and former partner and now prison inmate Joseph Collins in connection with the Refco securities fraud and financial meltdown, the 2nd Circuit rejected civil liability for both.
New York Law Journal2010-04-28 12:00:00 AM
Secondary actors such as attorneys can only be held liable for false statements in private damages actions under the securities laws if the statements are attributable to them at the time they are disseminated, a federal appeals court decided Tuesday.
Ruling in a civil suit brought against Mayer Brown and former partner and now prison inmate Joseph Collins in connection with the Refco Inc. securities fraud and financial meltdown, the 2nd U.S. Circuit Court of Appeals rejected civil liability for both in Pacific Investment Management Co. v. Mayer Brown, 09-1619-cv.
The suit was brought by plaintiffs who purchased Refco securities before the discovery that top officials at the brokerage firm had conducted fraudulent transactions between the firm and third parties to conceal hundreds of millions in Refco debt -- a scandal that drove the firm into bankruptcy.
Collins, who handled the Refco account at Mayer Brown, was convicted by a Southern District of New York jury in 2009 of two counts each of securities fraud and wire fraud and a single count of conspiracy for drafting portions of Refco offering documents that contained false information. Judge Robert Patterson sentenced him to serve seven years in prison in January. He has appealed his conviction.
In the civil suit, the plaintiffs claimed involvement by Mayer Brown and Collins in 17 sham loan transactions and charged they were responsible for false statements in a memorandum for an unregistered bond offering in July 2004, a registration statement for a subsequent registered bond offering and a registration statement for the company's initial public offering of stock in 2005.
Then Southern District Judge Gerard E. Lynch dismissed the case of In re Refco Inc. Sec. Litig., 609 F.Supp. 2d 304 (S.D.N.Y.), in 2009.
Tuesday, the circuit affirmed the lower court in a decision by Judges Jose A. Cabranes and Barrington D. Parker Jr. and, sitting by designation, Eastern District of New York Judge Carol B. Amon.
As it was before Lynch, the question on the appeal concerned two issues on the scope of Securities and Exchange Commission Rule 10b-5 liability.
Writing for the court, Cabranes said the plaintiffs "urge us to adopt a 'creator standard' and hold that a defendant can be liable for creating a false statement that investors rely on, regardless of whether that statement is attributed to the defendant at the time of the dissemination."
Cabranes acknowledged that, despite the "seemingly clear" requirement that false statements be directly attributed to the defendant in Wright v. Ernst & Young, 152 F.3d 169 (2d Cir. 1998), "our subsequent decisions may have created uncertainty or ambiguity with respect to when attribution is required" including in In re Scholastic Corp. Securities Litigation, 252 F.3d 63 (2d Cir. 2001).
Since Scholastic, he said, courts in the circuit "have struggled to reconcile its holding with our earlier holding in Wright," Cabranes said. Now, however, Cabranes declared that the circuit was rejecting "the creator standard for secondary liability under Rule 10b-5."
"Accordingly, secondary actors can be liable in a private action under rule 10b-5 for only those statements that are attributed directly to them," he said.
SCHEME TO DEFRAUD
The next question was whether plaintiffs' claims that Mayer Brown and Collins were part of a scheme to defraud investors were foreclosed by Stoneridge Investment Partners v. Scientific-Atlanta Inc., 552 U.S. 148 (2008).
In Stoneridge, the U.S. Supreme Court rejected 10b-5 claims brought against an issuing firm's customers and suppliers because the plaintiffs could not show they relied on those defendants' "own deceptive conduct" -- and instead had relied on the issuing firm's statements.
"We think that reasoning is consistent with an attribution requirement in the context of claims based on false statements," Cabranes said. "If a plaintiff must rely on a secondary actor's own deceptive conduct to state a claim under Rule 10b-5(a) and (c), it stands to reason that a plaintiff must rely on a secondary actor's own deceptive statements -- and not on statements conveyed to the public through another source and not attributed to the defendant -- to state a claim under Rule 10b-5(b)."
In a general sense, he said, Stoneridge "stands for the proposition that reliance is the critical element in private actions under Rule 10b-5," which "further supports an attribution requirement."
Cabranes also said that an attribution requirement "is consistent with our preference for a bright line rule distinguishing primary violations of rule 10b-5 from aiding and abetting."
"An attribution requirement makes clear -- to secondary actors and investors alike -- that those who sign or otherwise allow a statement to be attributed to them expose themselves to liability," he said.
That being said, the 2nd Circuit said Judge Lynch was right to dismiss the 10b-5 claims against Mayer Brown and Collins. The court went on to agree with Lynch's statement that, as "was the case in Stoneridge, it was Refco, not the Mayer Brown defendants, that filed the fraudulent financial statements."
Judge Parker issued a concurring opinion raising the possibility that the lack of clarity of an attribution requirement might be addressed by the full circuit or the U.S. Supreme Court.
He noted that the SEC submitted an amicus brief arguing that a creator standard is consistent with Supreme Court case law.
"The appellants in our case argue with some force against a result that shields Mayer Brown from damages in a circumstance where the partner responsible for the misleading statements was criminally convicted and received a prison term of seven years," he said.
The lawsuit is one of three against Mayer Brown that has been dismissed in the Southern District. Another suit that is still pending, one that Lynch refused to dismiss and is now being handled by Judge Jed S. Rakoff, is Thomas H. Lee Equity Fund v. Mayer, Brown, Rowe & Maw, 07-cv-06767. The suit alleges, among other allegations, racketeering in connection with Thomas H. Lee's $507 million leveraged buyout of a controlling interests in Refco in 2004.
James J. Sabella of Grant & Eisenhoffer represented Pacific Investment Management Co.
Sabella said he disagreed with the circuit's decision because "it practically insulates a lot of the perpetrators of fraud from liability to the victims of fraud. We think that's bad policy and we don't think that it's compelled by the language of the statute." Sabella said his client is considering its options.
Salvatore J. Graziano of Bernstein Litowitz Berger & Grossman represented plaintiff RH Capital Associates. He declined comment.
John K. Villa of Williams & Connolly represented Mayer Brown.
Mayer Brown issued a statement saying it would refrain from commenting except to state "our review of the evidence available to us shows that the firm acted in a professional, competent and ethical manner in its work on behalf of Refco."
William J. Schwartz of Cooley LLP represented Collins.