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On March 19, the 5th U.S. Circuit Court of Appeals issued its opinion in the ongoing Enron litigation, reversing class certification against various banking defendants. See Regents of the University of California v. Credit Suisse First Boston (USA) Inc., 2007 WL 816518 (5th Cir. Mar. 19, 2007). The Regents decision is significant for four reasons. First, by reversing class certification against the banking defendants, the court foreclosed classwide recovery against another set of potential actors allegedly involved the Enron collapse. Second, the Regents decision makes technical inroads on two U.S. Supreme Court precedents relating to presumed reliance: Affiliated Ute Citizens v. U.S., 406 U.S. 128 (1972), and Basic Inc. v. Levinson, 485 U.S. 224 (1988). Third, by further circumscribing the doctrine of presumed reliance in the securities arena, the 5th Circuit has made it more difficult for attorneys to advance the argument in nonsecurities class actions. Finally, the 5th Circuit has now joined a conflict among the circuit courts with respect to the scope of primary liability for secondary actors in schemes to defraud under the securities laws. The Regents decision, and conflicting opinions from sister circuits, sets the stage for Supreme Court resolution of this issue. The issue of presumed reliance is highly significant The issue of presumed reliance is highly significant in proposed class actions that allege common law or statutory claims sounding in fraud, misrepresentation or deceptive practices. The presence of a reliance element in a cause of action generally will defeat attempts to certify a damage class action because of a lack of predominance of common questions relating to individual class members’ reliance on a defendant’s conduct. In securities cases, however, some courts � based on Affiliated Ute and Basic � have developed a theory of “presumed reliance” that satisfies the class action requirement for predominance and relieves the class of individualized proof. In absence of a theory of presumed reliance, class claims sounding in fraud, misrepresentation and deceptive practices cannot be certified for class litigation. Since Affiliated Ute and Basic, the theory of presumed reliance has experienced a checkered and highly problematic evolution. Notwithstanding doctrinal difficulties in the securities arena, class counsel nonetheless have argued that Affiliated Ute and its progeny are authority for an expansive application of presumed reliance in nonsecurities cases. The 5th Circuit’s reversal of the Regents class is one portion of litigation engendered by Enron’s 2001 collapse. This securities class litigation was brought by the Regents of the University of California against banking defendants: Credit Suisse First Boston, Merrill Lynch & Co. Inc. and Barclays Bank PLC. The first of numerous Enron lawsuits was filed in October 2001, and in December the U.S. District Court for the Southern District of Texas consolidated more than 30 actions. The class action against the banks alleged that they entered into partnerships and transactions that allowed Enron to take liabilities off its books temporarily, and to book revenues from transactions when Enron actually was incurring debt. The plaintiffs alleged that the banks knew exactly why Enron was engaging in its seemingly irrational transactions. In addition, the plaintiffs alleged that although each defendant may not have been aware of how the other defendants were helping Enron misrepresent its financial status, the defendants generally knew that the other defendants were doing so, and that Enron was engaged in a long-term scheme to defraud investors by inflating revenue and disguising risk. In December 2002, the district court denied the banks’ motion to dismiss. On June 5, 2006, the district court certified the class action. Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA) Inc., 2006 U.S. Dist. Lexis 43146 (S.D. Texas 2006). The class sought $40 billion in damages. In certifying the class, the district court applied � 10(b)-5(c) of the securities laws and determined that a “deceptive act” included “participating in a transaction whose principal purpose and effect is to create a false appearance of revenues.” The court also held that � 10(b)-5(a) gave rise to joint and several liability among defendants who commit individual acts of deception in furtherance of a scheme. The court based its certification decision on a theory of scheme liability to find commonality. The court concluded that the plaintiff class could rely on a class-wide presumption of reliance for omissions and fraud on the market. Affiliated Ute permitted a presumption of reliance because the banks had failed in their duty not to engage in a fraudulent scheme. As to Basic‘s fraud-on-the-market presumption, the court held there was no need for a preliminary finding of market efficiency or investors’ reliance when plaintiffs pleaded their action under � 10-b(5)(a) or 10-b(5)(c). The 5th Circuit held that the district court misapplied the Affiliated Ute presumption of reliance. Consequently, only the Basic fraud-on-the-market presumption was potentially available to support class certification. However, the district court’s application of a fraud-on-the-market presumption derived from the court’s definition of a “deceptive act,” and was integral to its conclusion that class certification requirements were met. The 5th Circuit found that the definition of “deceptive act” dispositive of the class certification appeal. The 5th Circuit held that in order for a plaintiff to invoke the Affiliated Ute presumption of reliance on an omission, the plaintiff must (1) allege a case primarily based on omissions or nondisclosure, and (2) demonstrate that the defendant owed the plaintiff a duty of disclosure. See Abell v. Potomac Ins. Co., 858 F.2d 1104, 1119 (5th Cir. 1988). The court held that the California regents’ proposed class action failed this test. The banks were not fiduciaries or obligated to the plaintiffs, and did not owe any duty to disclose the nature of the transactions. Furthermore, the 5th Circuit held that “deception” within the meaning of � 10(b) requires that a defendant fail to satisfy a duty to disclose material information to a plaintiff. However, merely pleading that defendants failed to fulfill that duty by means of a scheme or an act, rather than by a misleading statement, does not permit plaintiffs to rely on the Affiliated Ute presumption. The 5th Circuit concluded that the plaintiffs had no expectation that the banks would supply them with information. There was no reason to expect that the plaintiffs were relying on the banks’ candor, and it was “only sensible to put plaintiffs to their proof that they individually relied on the banks’ omissions.” Regents, 2007 WL 816518, at *8. The 5th Circuit’s core rulings, however, focused on the inapplicability of Basic‘s fraud-on-the-market presumption. The court held that this presumption did not apply and that the district court had certified the class based on an erroneous interpretation of � 10(b). The 5th Circuit joined the 8th Circuit in declining to extend the scope of primary liability for securities violations to secondary actors. See Regents, 2007 WL 816518, at *10; cf. In re Charter Commc’ns Inc. Sec. Litig., 443 F.3d 987, 992 (8th Cir. 2006), with Simpson v. AOL Time Warner Inc., 452 F.3d 1040, 1048 (9th Cir. 2006). Construing the Supreme Court’s decision in Basic, the 5th Circuit held that to qualify for a fraud-on-the-market presumption, a plaintiff must indicate that a market is efficient and must allege that the defendant made public and material misrepresentations � the type of fraud on which an efficient market may be presumed to rely. The 5th Circuit concluded that the Regents plaintiffs had not alleged such fraud. Definition of ‘deceptive act’ liability ruled inconsistent In the most lengthy portion of its opinion, the 5th Circuit further concluded that the district court’s definition of “deceptive act” liability was inconsistent with Supreme Court precedent holding that � 10 of the securities laws does not give rise to aiding and abetting liability. Central Bank N.A. v. First Interstate Bank N.A., 511 U.S. 164 (1994). Even assuming, as the plaintiffs alleged, that Enron committed fraud by misstating its accounts, the banks only aided and abetted the fraud by engaging in transactions to make it more plausible. But a � 10(b) claim does not give rise to aiding and abetting liability. After a lengthy textual and doctrinal exegesis on the meaning of the terms “deceptive,” “device” and “manipulative,” the 5th Circuit concluded that the district court’s definition of deceptive acts swept too broadly, and that the banks’ transactions were not properly embraced by that phrase. Enron had a duty to its shareholders; the banks did not. The banks participation in the transactions, regardless of their purpose or effect, did not give rise to primary liability under � 10(b). Finally, the 5th Circuit cited policy reasons in support of its restrictive rule of primary liability, limiting aiding-and-abetting liability for secondary actors under � 10(b): such a strict construction against “inputting liability for aiding and abetting liability for secondary actors under the rubric of ‘deceptive acts’ or ‘schemes’ gives rise to the type of certainty the Supreme Court sought in Central Bank.” Regents, 2007 WL 816518, at *14. The court concluded: “We mention policy only to demonstrate that, even considering the scope of the Enron disaster, Congress was not irrational to promote plain legal standards for the actors in the financial markets by limiting secondary liability.” Regents, 2007 WL 816518, at *15. Linda S. Mullenix holds the Fulbright Senior Distinguished Chair in Law at Trento, Italy, for spring 2007. She can be reached at [email protected].

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