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A federal judge has declined to dismiss a civil suit brought by a husband and wife who claim that Sidley Austin Brown & Wood and Deutsche Bank Securities Inc., offered a tax shelter the firms knew would be challenged by the Internal Revenue Service. Southern District Judge Shira Scheindlin said William and Sharon Seippel’s complaint sufficiently alleged fraud and that the couple’s allegations against the defendants could stand because they went further than alleging aiding and abetting liability. Judge Scheindlin’s ruling came on motions to dismiss the second amended complaint in Seippel v. Sidley Austin Brown & Wood, 03 Civ. 6942. The first complaint, which alleged claims including racketeering and excessive fees, was dismissed last year by the judge. The tax shelters at issue involved digital options or swaps in foreign currency, known as COBRA. Alleged misrepresentations about the legality of the shelters were made by Charles Paul of Ernst & Young, but the Seippels charged that Paul was acting on behalf of Deutsche Bank and others, including Brown & Wood, the previous incarnation of Sidley Austin. Scheindlin quickly disposed of the defendants’ first objection in the motions to dismiss, finding that the Seippels had alleged fraud with sufficient particularity under the Private Securities Litigation Reform Act of 1995. The judge then ruled that the claims regarding the COBRA transaction were not time barred, finding that the defendants did not “point to any press reports, complaints or other public documents” referring to an IRS notice on the propriety of COBRA, “or explicitly calling COBRA’s lawfulness into question, or to anything that might have caused ordinary taxpayers to suspect that it was not safe to rely on the advice of their tax lawyers.” Scheindlin then turned to the firms’ claim that the Seippels had alleged “aiding and abetting” liability, for which the U.S. Supreme Court has held there is no private right of action under the federal securities laws. The U.S. Supreme Court held in Central Bank of Denver, N.A., v. First Interstate Bank of Denver, 511 U.S. 164 (1994), that in order for a person or entity to be held liable for a material misstatement or omission or for committing a manipulative act they must be a “primary violator.” Scheindlin said the 2nd U.S. Circuit Court of Appeals in Wright v. Ernst & Young, 152 F.3d 169 (1998), interpreting Central Bank, adopted a “bright line” rule that rejected holding secondary actors liable under a “substantial participation test.” Instead, the circuit held that a “defendant must actually make a false or misleading statement in order to be held liable under Section 10(b),” and “a secondary actor cannot incur primary liability under the Act for a statement not attributed to that actor at the time of its dissemination — that is, in advance of the investment decision.” But Scheindlin noted that the Seippels’ allegations “are very different from those at issue in Central Bank and Wright,” where the defendants knew of the purported fraud, but only through transactions with the defrauders, and failed to expose it. “In contrast, the Seippels do not allege that defendants merely assisted in a fraud conceived and perpetrated by Ernst & Young,” she said. “Rather, the Seippels allege that defendants engineered and were key members of the conspiracy to defraud.” The Seippels, she said, charged that the defendants conceived COBRA and agreed that Ernst & Young would sell it to taxpayers. “In essence, the Seippels allege that defendants made misrepresentations to them, albeit indirectly, using Paul as their agent and mouthpiece,” she said, “If true, these allegations are sufficient to hold defendants liable as primary violators,” because the Wright case “does not require that a defendant directly communicate the alleged misrepresentation to the plaintiff.” Fensterstock & Partners represented the Seippels. Covington & Burling; Frankel & Abrams; and Munger Tolles & Olson of Los Angeles represented Sidley Austin. Dewey Ballantine represented Deutsche Bank Securities.

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