Amicus Curiae Brief — Stoneridge Inv. Partners v. Scientific-Atl.

39 PAS No. 06-43 | SLED

| JUN + 9007

IN THE FFICE OF THE CLERK

uP

Supreme Court of the Gnited me Pe” COURT, U.S.

STONERIDGE INVESTMENT PARTNERS, LLC.

Petitioner,

V.

SCIENTIFIC-ATLANTA, INC. and MOTOROLA, INC..

Respondents.

On Writ of Certiorari to the

United States Court of Appeals

for the Eighth Circuit

BRIEF OF THE REGENTS OF

THE UNIVERSITY OF CALIFORNIA,

COURT-APPOINTED LEAD PLAINTIFF IN THE

ENRON SECURITIES LITIGATION, AS

AMICUS CURIAE IN SUPPORT OF PETITIONER

WILLIAM S. LERACH

(Counsel of Record)

PATRICK J. COUGHLIN

HELEN J. HODGES

BYRON S. GEORGIOU

ERIC ALAN ISAACSON

SPENCER A. BURKHOLZ

JOSEPH D. DALEY

LERACH COUGHLIN STOIA GELLER

RUDMAN & ROBBINS LLP

655 West Broadway, Suite 1900

San Diego. CA 92101

(619) 231-1058

Counsel for Amicus Curiae

The Regents of The University of California

WILSON-EPES PRINTING CO., INC. — (202) 789-0096 -— WasHinGron. D.C. 20002

@ ZF co

QUESTION PRESENTED

Does liability exist under §10(b) of the Securities Ex-

change Act of 1934 and Securities and Exchange Commis-

sion Rule 10b-5, where an actor knowingly uses or employs

deceptive devices and contrivances as part of a scheme to

defraud investors in another public company, but itself makes

no affirmative misrepresentations to the market?

(i)

TABLE OF CONTENTS

Page

QUESTION PRESENTED. .......ccccsccccocccerscssssscsccsccseeee i

TABLE OF AUTHORITIES.............cccccsccccsseccssrcssoesseees iv

INTEREST OF AMICUS CURIAE .......ccccccssessesesseeseees 1

Ee OIE cxnecinciicsintnrasesennssenceenrencsnomensensens 5

SUMMARY OF ARGUMENT .............cccccsesssessseeeeesees 15

ITT eicinicinciniijtinisndinnineansemininnmnnciteonmanimeine 16

I. THE DECISION BELOW AND ENRON

DEPART FROM THE STATUTORY TEXT... 16

Il. THE LIABILITY STANDARD FRAMED BY

THE SEC AND ADOPTED IN SIMPSON

COMPORTS WITH STATUTORY TEXT

AND THIS COURT’S PRECEDENTS............... 24

Ill. THE FACTS IN ENRON SHOW THAT A

CLEAR DISTINCTION MAY BE DRAWN

BETWEEN PRIMARY LIABILITY BASED

ON DECEPTIVE CONDUCT AND MERE

AIDING AND ABETTING .............ccccsseecseesees 29

EINE scncrenisonsniepetentipcinnsiimecntecssnneienseniineenate 30

(iii)

iv

TABLE OF AUTHORITIES

CASES Page

Aaron v. SEC,

ee 18, 27

Affiliated Ute Citizens v. United States,

TC a 16, 27

Auer v. Robbins,

rn ianiniamninataniensiaiiin 9

Basic Inc. v. Levinson,

RN I IIT TIIITED ac ssccenecennsascnnensoonssenenssssnenties passim

Blackie v. Barrack,

524 F.2d 891 (Sth Cir. 1975) .........ccccecceseeseeeeeeees 16

Central Bank N.A. v. First Interstate Bank N.A.,

| ON passim

Chevron, U.S.A., Inc. v. NRDC,

gE 9

Chiarella v. United States,

BR Ge A IED ccsccerecscccsscescnsecpsssectsenecesonten 22, 23

Competitive Assocs., Inc. v. Laventhol, Krekstein,

Horwath & Horwath,

516 F.2d 811 (2d Cir. 1975) 0.0.2... ceeeeeeeeeeees 16

Cooper v. Pickett,

137 F.3d 616 (Sth Cir. 1997)...........ccccccssccessceeees 16, 25

Dura Pharms., Inc. v. Broudo,

I I iiiicncnccinscccsnenecesenesensecenenicees 20

Ernst & Ernst v. Hochfelder,

RN TT sinc ccrncniccncnccnncnsnnnssnonsoetnenees 17

Hamilton v. Regents of the Univ. of Cal.,

TR 1

Harris v. United States,

48 F.2d 771 (Sth Cir. 1931).............ccccccccssecsessees 28

Herman & MacLean v. Huddleston,

ce 20

In re Charter Commc’ns., Inc.,

443 F.3d-987 (8th Cir. 2006) ...............cccccceeeeeees 4,9

v

TABLE OF AUTHORITIES—Continued

Page

In re Enron Corp. Sec. Litig.,

206 F.R.D. 427 (S.D. Tex. 2002) .............cecseeee 1,2, 6

In re Enron Corp. Sec. Litig.,

235 F. Supp. 2d 549 (S.D. Tex. 2002)............... 2,6

in re Enron Corp. Sec. Litig.,

236 F.R.D. 313 (S.D. Tex. 2006) ...............cce00 3,8

In re Enron Corp. Sec. Litig.,

310 F. Supp. 2d 819 (S.D. Tex. 2004)............... 2, 6

In re Enron Corp. Sec. Litig.,

No. H-01-3624, 2006 U.S. Dist. LEXIS 88121

(S.D. Tex. Dec. 4, 2006)..........ccccsscocssecesessseseess 7

In re Enron Corp. Sec. Litig.,

No. H-01-3624, 2006 U.S. Dist. LEXIS 43146

BR ee passim

In re Global Crossing, Ltd. Sec. Litig.,

322 F. Supp. 2d 319 (S.D.N.Y. 2004)............... 16

In re Initial Pub. Offering Sec. Litig.,

241 F. Supp. 2d 281 (S.D.N.Y. 2003)................ 16

In re Lernout & Hauspie Sec. Litig., :

236 F. Supp. 2d 161 (D. Mass. 2003)................ 16

In re Parmalat Sec. Litig.,

376 F. Supp. 2d 472 (S.D.N.Y. 2005)............... passim

Ishimatsu v. Regents of Univ. of Cal.,

266 Cal. App. 2d 854, 72 Cal. Rptr. 756 (1968) ... ]

Leonard v. Springer,

is SE Ct ccciccnescnsenctscnssnsscssomssnsiane 19

Lipton v. Documation, Inc.,

734 F.2d 740 (11th Cir. 1984) occ cceeeeseees 28

Nat’l Cable & Telecommc’ns. Ass’n v. Brand X

Internet Servs.,

ee I II cetenessnscccescvsenensnnssnnaninnniinsiions 9

Neder v. United States,

Br Ts WE vintinsesstetnincisinicintaatinienaioain 20

vi

TABLE OF AUTHORITIES—Continued

Page

Pasquantino v. United States,

A tT trcntnsscempesnpenessasnssnscnsssscesees 17

Quaak v. Dexia, S.A.,

357 F. Supp. 2d 330 (D. Mass. 2005)................ 16

Regents of the Univ. of Cal. v. Credit Suisse First

Boston,

482 F.3d 372 (Sth Cir. 2007) .00........ccccscceeeeeeee passim

Richardson v. MacArthur,

451 F.2d 35 (10th Cir. 1971) .........ceeeeecceeseeneees a

SEC v. Hopper,

No. H-04-1054, 2006 U.S. Dist. LEXIS 17772

(S.D. Tex. Mar. 24, 2006)............ccccccecesseeceeeeenes 16

SEC v. U.S. Envil., Inc.,

155 F.3d 107 (2d Cir. 1998) .0........cccceceeeeeseeseees 16

SEC v. Zandford,

nes ncecnaresencnmngannennsomnncen passim

Safeco Ins. Co. of Am. v. Burr,

No. 06-84, U.S. __, 2007 U.S. LEXIS 6963

TTT TTT cic cseecnensesscnnnssnssemnecscpocnossen 20

Simpson v. AOL Time Warner,

452 F.3d 1040 (9th Cir. 2006) ............ccccceceseeeees passim

Smith v. United States,

TT cE 17

Stewart v. Wyoming Cattle Ranche Co.,

BEIT cc cerersccetsniasccsscssessccncesecescosee 19

Sundstrand Corp. v. Sun Chem. Corp.,

553 F.2d 1033 (7th Cir. 1977) ..........:.ccccececeeesees 20

Superintendent of Ins. v. Banker's Life &

Casualty Co.,

TTT its ecerscnmnicsncenesesnansenrenecanane 16, 26, 28

United States v. Brown,

5 F. Supp. 81 (S.D.N.Y. 1933), aff'd, 79 F.2d

I ici aernsnperineenmnmenenncennats 19, 20, 28

Vii

TABLE OF AUTHORITIES—Continued

Page

United States v. Colton,

231 F.3d 890 (4th Cir. 2000) 200.0... ceeeeeeeeeeees 19

United States v. O'Hagan,

Be I IE sciniiasenccenscntnscrsemsiinnonne 22, 23, 28

STATUTES, RULES AND REGULATIONS

15 U.S.C.

ITT cschierinsignsttameseenenenunpenstammensenemeemennvenepenmniaieds passim

TIT cncsncperideasanedegpanegnnnmnnnennneenianiatin l

ITT iitotiieinarteiatritrentaadgeigemmigieeeanenionnieamunuints 6

«ener 29

IT dso ainasitasin snectienaennrpaninaterannnntinananien 29

Federal Rules of Civil Procedure

eee Tae 6

ETT ae nee TEE 8

17 C.F.R

inst esnasensnenseepennsenntanennssemnmmeunseuietiinin passim

TER rea Te 9, 14, 22

ina aera ererpnaeanaateeannaitinaeninls 22, 24

California Constitution

nasties eenremeapncmnnunintenenesiinitinins ]

LEGISLATIVE HISTORY

Private Securities Litigation Reform Act of 1995,

Pub. L. 104-67, 109 Stat. 737 ...........ccccccseseeeeeees 29

SECONDARY AUTHORITIES

A.A. Berle, Liability for Stock Market Manipula-

tion, (1931)

Be Ties Gi, AID ccienitnisttiiinsinnccemseciiagnmsians 20

A.A. Berle, Stock Market Manipulation, (1938)

PD Gs GET, I ecntzancccntrtecticrannnmnennnitis 20, 28

TABLE OF AUTHORITIES—Continued

Page

Ballentine ’s Law Dictionary 1142 (3d ed. 1969) .. 27

Restatement of Torts (1938)

——_EESRSEREERE Kons oO eee 20

Restatement (Second) of Torts (1979)

UTE vinitid ninadiininacnepdatinatipaeniaicntaninpesennmessenenssce 20

Webster's International Dictionary (2d ed. 1934)... 18, 27

William J. Prosser, Handbook of the Law of Torts

(1st ed. 1941)

INTEREST OF AMICUS CURIAE

The Regents of the University of California (“The

Regents”), which suffered losses exceeding $140 million in

connection with the notorious Enron fraud, appears in this

matter in its capacity as the court-appointed Lead Plaintiff

authorized under 15 U.S.C. §78u-4(a)(3) to act in connection

with the Enron securities litigation on behalf of a class of all

persons who purchased the publicly traded securities of Enron

Corporation between October 19, 1998, and November 27,

2001. See In re Enron Corp. Sec. Litig., 206 F.R.D. 427

(S.D. Tex. 2002).

With a mission of teaching, research, and public service,

the University of California is the nation’s premier research

university, and The Regents is the instrumentality of the state,

“fully empowered in respect of the organization and govern-

ment of the university, which, as it has been held, is a consti-

tutional department or function of the state government.”

With 10 campuses, more than 201,000 students, and better

than 160,000 employees, the University is governed by its 26-

member Board of Regents. Pursuant to its constitutional

authority, The Regents serves as a fiduciary for the Univer-

sity’s pension and endowment funds, overseeing more than

$50 billion invested in publicly traded U.S. securities.

The Regents accordingly has a strong interest in enforce-

ment of our nation’s securities laws — to ensure the transpar-

' This amicus brief is filed with all parties’ consent. No counsel for

any party to this matter authored this brief or any portion of it, and no

party has made any monetary contribution to the preparation or submis-

sion of this brief. As noted in text, The Regents is court-appointed Lead

Plaintiff in the Enron securities litigation. The Regents or its counsel may

ultimately seek compensation in that case for the work and expenses

incurred in preparing this brief.

? Hamilton v. Regents of the Univ. of Cal., 293 U.S. 245, 257 (1934);

see Cal. Const. art. IX, §9; Ishimatsu v. Regents of Univ. of Cal., 266 Cal.

App. 2d 854, 864, 72 Cal. Rptr. 756, 763 (1968). Citations and footnotes

are omitted and emphasis is added unless otherwise noted.

2

ency and integrity of the securities markets, and that victims

of fraud are compensated. In February 2002, moreover, The

Regents was appointed by the United States District Court for

the Southern District of Texas to serve as Lead Plaintiff for

a class of investors who purchased Enron securities. See

Enron, 206 F.R.D. at 454-59. In that capacity The Regents

is prosecuting claims against many defendants who, acting

together, hid Enron’s debt and fabricated Enron’s financial

results — thereby defrauding many thousands of investors out

of billions of dollars. Many lost their life savings. The Re-

gents suffered more than $140 million in losses due to fraud

in connection with its purchases of Enron securities.

Featuring a complex scheme perpetrated by many partici-

pants and over many years, the Enron fraud is emblematic

of the recent wave of corporate scandals that has shaken

confidence in U.S. securities markets. See Jn re Enron Corp.

Sec. Litig., 235 F. Supp. 2d 549, 613-85, 692-707 (S.D. Tex.

2002).? Denying motions to dismiss, the district court in

Enron held that The Regents was entitled to proceed under

§10(b) against entities, including Merrill Lynch and Credit

Suisse, who designed and implemented deceptive financial

transactions in order to hide Enron’s debt and inflate Enron’s

reported financial results, because they had actively engaged

in a scheme to defraud investors by executing their deceptive

devices and contrivances. See, e.g., In re Enron Corp. Sec.

Litig., 310 F. Supp. 2d 819, 827-30 (S.D. Tex. 2004);* Enron,

235 F. Supp. 2d at 581-94, 613-707.

The district court then certified a class, holding again that

§10(b)’s proscription of “deceptive” devices is broad enough

to cover Enron’s bankers’ central role in “‘transaction(s}

>The quoted opinion is reproduced in the Appendix to the Enron

Petition for Certioriari, captioned The Regents of the Univ. of Cal. v.

Merrill Lynch Pierce Fenner & Smith, No. 06-1341, at 407a-678a cited

hereafter as “Enron Pet. Appx.”

* Enron Pet. Appx. at 329a-406a.

3

whose principal purpose and effect is to create a false appear-

ance of revenues.”” Jn re Enron Corp. Sec. Litig., No. H-01-

3624, 2006 U.S. Dist. LEXIS 43146, at *167 (S.D. : Tex. June

5, 2006) (first class-certification opinion and order)°; see also

In re Enron Corp. Sec. Litig., 236 F.R.D. 313 (6. D. Tex.

2006) (second class-certification opinion and order).® Judge

Harmon’s opinion specifically tracked the SEC’s position that

under §10(b) and Rule 10b-5 “a ‘deceptive act’ includes a

‘transaction whose principal purpose and effect is to create a

false appearance of revenues,’ which can be accomplished by

acts as well as by words.” Enron, 2006 U.S. Dist. LEXIS

43146, at *167. The Enron district court found persuasive the

SEC’s distinctions between deceptive acts, on the one hand,

and aiding and abetting, on the other, and expressly adopted

the SEC’s approach to certify a class. Jd. at *173. The SEC

itself had explained, in an amicus curiae brief before the

Ninth Circuit, that:

“[(D]eceptive acts under Section 10(b) include conduct

beyond the making of false statements or misleading

omissions, for facts effectively can be misrepresented by

actions as well as words. For example, if an investment

bank falsely states that a client company has sound

credit, there is no dispute that it can be primarily liable.

If the bank creates an off-balance-sheet sham entity that

has the purpose and effect of hiding the company debt, it

has achieved the same deception, and liability should be

equally available.”

Enron, 2006 U.S. Dist. LEXIS 43146, at *165 (quoting SEC

amicus curiae brief from Simpson v. AOL Time Warner, 452

F.3d 1040 (9th Cir. 2006), petition for cert. filed, (Oct. 19,

2006) (No. 06-560)).’

> Enron Pet. Appx. at 58a-296a.

® Enron Pet. Appx. at 297a-310a.

’ The Brief of The SEC as Amicus Curiae, in Simpson v. Homestore,

Inc., No. 04-55665 (9th Cir. Oct. 22, 2004), is available at www.sec.gov/

litigation/briefs/homestore 192194 pdf.

4

Enron’s bankers, who had devised and executed the sham

transactions that hid Enron’s debt and that generated its

phony financial results, obtained leave from the Fifth Circuit

to take an interlocutory appeal. See Regents of the Univ. of

Cal. v. Credit Suisse First Boston, 482 F.3d 372 (Sth Cir.

2007) (“Enron”). Recognizing that The Regents stated valid

claims under the test formulated by the SEC, and adopted by

the Ninth Circuit in Simpson, 452 F.3d 1040, the Fifth Circuit

nonetheless reversed — ruling that the claims failed under the

Eighth Circuit’s competing standard stated in Jn re Charter

Commc’ns., Inc., 443 F.3d 987 (8th Cir. 2006), the decision

presently under review.

The Enron panel majority wrote that “the Eighth and Ninth

Circuits have split with respect to the scope of primary liabil-

ity for secondary actors” who engage in conduct designed to

mislead investors. Enron, 482 F.3d at 386. The panel major-

ity acknowledged: “The district court adopts a rule advocated

by the Securities and Exchange Commissior (‘SEC’)...

under which primary liability attaches to anyone who engages

in a ‘transaction whose principal purpose and effect is to

create a false appearance of revenues.”” Jd. But the Fifth

Circuit rejected that test: “We agree with the Eighth Circuit

that the SEC’s proposed test . . . is too broad to fit within the

contours of §10(b).” Jd. at 386-87. “The Eighth Circuit,

unlike the Ninth,” the Fifth Circuit majority explained, has

taken this Court’s “decisions collectively to mean that ‘“de-

ceptive” conduct involves either a misstatement or a failure

to disclose by one who has a duty to disclose.”” Jd. at 388

(quoting Charter, 443 F.3d at 990). Thus, though Enron, as

an issuer of securities, was under a duty to issue truthful

financial statements, the Fifth Circuit held that its bankers

were free to engage in whatever deceptive practices they

pleased — so long as they said nothing about it. See id.

The Regents’ petition for certiorari in that case, in which

the Fifth Circuit followed the decision below in this proceed-

ing to terminate the Enron class action, see Enron, 482 F.3d

5

at 386-88, currently is pending before this Court as The

Regents of the Univ. of Cal. v. Merrill Lynch, Pierce, Fenner

& Smith, Inc., No. 06-1341, petition for cert. filed (Apr. 5,

2007).

The decision in this case is apt to be critical to claims of

The Regents and other victims of the Enron fraud. The

Regents as Lead Plaintiff in the Enron litigation, and the class

of investors that it was appointed to represent, obviously have

a strong interest in ensuring that this Court adequately con-

siders the implications of its decision in this case for other

cases that — like Enron — involve complex fraud schemes.

Moreover, the facts in Enron show that a clear line can be

drawn between aiding-and-abetting liability and primary lia-

bility based on deliberately deceptive conduct designed to

mislead investors.

THE ENRON FRAUD

The Regents’ Enron class action arises out of the worst

securities fraud in recent history, and demonstrates the differ-

ence between conduct that merely aids or abets another’s

wrongdoing, and conduct that is itself deliberately deceptive.

Thousands of investors lost billions of dollars in an

acknowledged fraud that produced many criminal and regula-

tory proceedings, investigations, and hearings, all document-

ing massive financial wrongdoing. But Enron’s bankruptcy,

the collapse of its accountants, limited insurance, and govern-

ment seizure of key insiders’ assets, all appeared to doom the

victimized investors to a minimal recovery in their §10(b)/

Rule 10b-5 civil class-action suit — except for claims the

investors asserted against certain large banks (the “Banks”),

which had used deceptive devices and contrivances to hide

Enron’s debt and fabricate phony financial results in a delib-

erate scheme to defraud Enron investors.

The Regents alleged the Banks reaped huge profits by

engaging in the scheme in which they:

6

e structured contrived financial transactions to falsify

Enron’s financial statements (generating fake profits

and hiding billions of dollars of debt);

e sold billions in new Enron securities to the public (via

prospectuses and circulars containing the falsified

financial statements), thereby raising the fresh funds

required to keep the Enron Ponzi scheme going; and

e had their securities analysts recommend Enron’s stock

via false analyst reports. This conduct inflated Enron’s

securities until the truth came out during 2001, i

the securities’ prices to plummet and become worthless.

The Enron district court, relying on The Regents’ com-

plaint and on briefs submitted by the SEC, upheld the factual

adequacy and legal sufficiency of allegations that the Banks

violated §10(b) by engaging in the fraudulent scheme.” Over

the next five years, the district court refined its rulings re-

garding scheme liability to “tighten” the standard and require

that each bank used a deceptive act or contrivance — reflect-

ing new decisions,'® and an SEC amicus curiae filing in

* See Enron, 235 F. Supp. 2d at 613-14, 631, 633-37 (noting The Re-

gents’ allegation that “[iJn 2001, matters at Enron began to fall apart”

and describing events leading to Enron’s December 2, 2001, bankruptcy);

Enron, 310 F. Supp. 2d at 827, 832, 836 (same). The Regents’ pension

fund, containing retirement savings of nearly 500,000 present and former

employees of the University of California system, lost more than $140

million in the collapse of Enron’s stock. See Enron, 206 F.R.D. at 454.

* The pleading satisfied all of the falsity and scienter pleading require-

ments imposed by both Fed. R. Civ. P. 9(b) and the 1934 Act §21D(b), 15

U.S.C. §78u-4(b), as to Merrill Lynch and Credit Suisse. See Enron, 310 F.

Supp. 2d at 827-30; Enron, 235 F. Supp. 2d at 613-707.

The district court relied on Judge Kaplan’s extensive discussion of

the relevant law in /n re Parmalat Sec. Litig., 376 F. Supp. 2d 472, 504

(S.D.N.Y. 2005):

The defendants’ argument that they were at most aiders and abet-

tors of a program pursuant to which Parmalat made misrepresenta-

tions on its financial statements misses the mark. The transactions in

7

Simpson, 452 F.3d 1040, supporting scheme iiability. The

district court ultimately adopted the SEC’s test for scheme

liability.""

The Regents’ counsel analyzed millions of documents and

took hundreds of depositions, and Enron’s court-appointed

Bankruptcy Examiners’ investigations detailed the Banks’

“knowing participation” in the fraud.'? In 2006, certain banks

settled the fraud claims against them for $6.6 billion, stipulat-

ing to a settlement class.’

which the defendants engaged were by nature deceptive. They de-

pended on a fiction, namely that the invoices had value. It is impos-

sible to separate the deceptive nature of the transactions from the

deception actually practiced upon Parmalat’s investors. Neither the

statute nor the rule requires such a distinction.

" Enron, 2006 U.S. Dist. LEXIS 43146, at *165-*173. Accordingly, in

order for scheme liability to exist, the district court required that the de-

fendant commit a deceptive act. For example:

Lead Plaintiff must allege specific details that show that a structure

of the entity or a transaction that was created by Barclays was inher-

ently deceptive and that Barclays used and employed it to deceive

investors, not that Enron, its officers and accountants subsequently

used the entity improperly to cook its books, or that Barclays en-

gaged in acts, practices, or a course of business that operated as a

fraud or deceit upon any person in connection with the purchase or

sale of an Enron security.

In re Enron Corp. Sec. Litig., No. H-01-3624, 2006 U.S. Dist. LEXIS

88121, at *21-*22 (S.D. Tex. Dec. 4, 2006).

? Third Interim Report of Neal Batson, court-Appointed Examiner at

82 (“Merrill Lynch had actual knowledge of the wrongful conduct in these

transactions ... .”); Final Report of Neal Batson, court-Appointed Exam-

iner at 75 (“CSFB had actual knowledge of the wrongful conduct in

these transactions . . . .”); Third Interim Report of Neal Batson, Court-

Appointed Examiner at 66 (“Barclays had actual knowledge of the

wrongful conduct in these transactions .. . .”).

The settlements were: Citibank — $2.0 billion, J.P. Morgan Chase

— $2.2 billion, and CIBC — $2.4 billion. Other settlements brought the

total to $7.3 billion. The total damages exceed $40 billion.

in July 2006, after considering expert testimony and with

the benefit of a well-developed evidentiary record, the district

court certified for trial a class of purchasers of Enron’s

publicly traded securities. Enron, 2006 U.S. Dist. LEXIS

43146; Enron, 236 F.R.D. 313. With trial scheduled for April

16, 2007, however, the Fifth Circuit accepted the remaining

Banks’ Rule 23(f) appeal challenging class certification on

the ground that they could not be liable under §10(b). Enron

Cert. Pet. Appx. at 679a-680a. Then, less than 30 days before

trial, a fractured Fifth Circuit panel reversed. See Enron, 482

F.2d 372.

Two judges ruled, over vigorous objections from Judge

James L. Dennis (see id. at 394-407), that (i) the Banks could

not be liable under §10(b)/Rule 10b-5 for engaging in a

scheme to defraud Enron’s shareholders because they made no

false statements; thus (ii) no class-wide presumption of reli-

ance under Basic Inc. v. Levinson, 485 U.S. 224 (1988), was

available; and therefore (iii) no class may be certified. Enron,

482 F.3d at 385-94. The majority acknowledged that its deci-

sion directly conflicted both with the Ninth Circuit’s decision

in Simpson, 452 F.3d 1040, and with the SEC’s position.

The Enron majority acknowledged this Court’s admonition

in Central Bank that “[t]he absence of §10(b) aiding and

abetting liability does not mean that secondary actors in the

securities markets are always free from liability under the

securities Acts.” Central Bank N.A. v. First Interstate Bank

N.A., 511 U.S. 164, 191 (1994); see Enron, 482 F.3d at 386.

But the lower courts had generated a Circuit “split” on the “the

scope of primary liability for secondary actors” (id. at 386),

with the Ninth Circuit holding in Simpson, 452 F.3d at 1048,

that a defendant may be “liable as a primary violator of §10(b)

'* Enron, 482 F.3d at 385-90. The majority also implicitly rejected the

views of the Attorneys General of 30 states who had filed an amicus

curiae brief supporting scheme liability. See Amicus Curiae Brief of the

State Attorneys General, filed in Enron.

9

for participation in a ‘scheme to defraud,”” if it “engaged in

conduct that had the principal purpose and effect of creating a

false appearance of fact in furtherance of the scheme,” while

the Eighth Circuit held in Charter, 443 F.3d at 992, that “any

defendant who does not make or affirmatively cause to be

made a fraudulent misstatement or omission, or who does not

directly engage in manipulative securities trading practices, is

at most guilty of aiding and abetting and cannot be held liable

under §10(b) or any subpart of Rule 10b-5.”

The SEC’s position was that §10(b)’s text prohibits,

“within the rubric of engaging in a deceptive act, engaging in

a transaction whose principal purpose and effect is to create a

false appearance of revenues,” drawing a clear distinction

between primary and secondary liability: “Any person who

directly or indirectly engages in a manipulative or deceptive

act as part of a scheme to defraud can be a primary violator of

Section 10(b) and Rule 10b-5(a); any person who provides

assistance to other participants in a scheme but does not

himself engage in a manipulative or deceptive act can only be

an aider and abettor.””°

'S Brief of the SEC as Amicus Curiae in Simpson, supra n.7, at 16-18;

see Simpson, 452 F.3d at 1048. Deference is due the SEC’s interpretation.

See SEC v. Zandford, 535 U.S. 813, 819-20 (2002); Nat'l Cable &

Telecommc'ns. Ass'n v. Brand X Internet Servs., 545 U.S. 967, 980

(2005); Chevron, U.S.A., Inc. v. NRDC, 467 U.S. 837, 844 (1984); Auer v.

Robbins, 519 U.S. 452, 462-63 (1997). As the district court explained in

Enron, 2006 U.S. Dist. LEXIS 43146, at *165, quoting the SEC Amicus

Curiae brief:

“[D]eceptive acts under Section 10(b) include conduct beyond the

making of false statements or misleading omissions, for facts effec-

tively can be misrepresented by action as well as words. For

example, if an investment bank falsely states that a client company

has sound credit, there is no dispute that it can be primarily liable.

If the bank creates an off-balance-sheet sham entity that has the

purpose and effect of hiding the company debt, it has achieved the

same deception, and liability should be equally available.”

10

Acknowledging the SEC’s view supports scheme liability,

so that primary liability attaches to anyone who engages in a

“*transaction whose principal purpose and effect is to create

a false appearance of revenues,” Enron, 482 F.3d at 386, the

Enron majority nevertheless concluded “[w]e agree with the

Eighth Circuit that the SEC’s proposed test . . . is too broad to

fit within the contours of §10(b).” Jd. at 386-87.

“Presuming plaintiffs’ allegations to be true,”’* the Enron

majority acknowledged The Regents had alleged: (i) that the

Banks entered into “transactions that allowed Enron .. . to

take liabilities off its books temporarily and to book revenue

from the transactions when it was actually incurring debt

[and] . . . these transactions . . . allowed Enron to misstate its

financial condition” — which “gave a misleading impression

of the value of Enron securities that were already on the

market”; (ii) “that the banks knew exactly why Enron was

engaging in seemingly irrational transactions”;’’ and (iii) that

the “banks intended to profit by helping the [Enron]

executives maintain [the] illusion” of revenues — “inflating

their stock price” — all the while knowing that “Enron was

engaged in a long-term scheme to defraud investors . . . by

inflating revenue and disguising risk and liability through its

... transactions with the banks.” Enron, 482 F.3d at 377.

The Banks’ conduct was inherently deceptive. They struc-

tured and engaged in non-arm’s-length transactions with Enron

involving sham entities. These transactions, including fake

commodity and energy trades, had no actual business purpose,

but rather were designed solely to get cash to Enron while

disguising loans to conceal Enron’s debt, or to create fictitious

operating revenues or earnings. These were “financial state-

ment” transactions, i.e., “structured finance” deals, intended to

directly distort Enron’s financial statements, not ordinary

1© Enron, 482 F.3d at 386.

7 Enron, 482 F.3d at 376-77, 391.

1]

arm’s-length commercial transactions later misaccounted for

by Enron. The Banks’ documents admit the deals were

designed to “raise disguised debf’ and provide “off-balance

sheet parking lots” for distressed assets, that the Banks had

received secret oral guarantees, that the Banks “will be taken

out” or the deal will “unwind,” and that the contrived trans-

actions were “servicing” Enron’s “particular accounting

needs,” which “had great value in their stock price.”™*

Enron’s former CFO Andrew Fastow, after admitting his

crimes, testified and laid it out. He said “[i]n many instances,

the banks primarily devised the financial structures.” “In

many cases, the banks brought us these structures, and we

executed the transactions with the banks.” 8R:36721 (Fastow

Decl., 96); CORO1758-59 (Fastow Depo.). They “worked

together, intentionally and knowingly, fo engage in trans-

actions that would affect Enron's financial statements.”

8R:36722 (Fastow Decl., $7). According to Fastow:

When you boil it all down, Enron wanted to paint a

picture of itself to the outside world that was different

from the reality inside Enron. And these structured

financial transactions, along with other things that

Enron did, created that deception.

CORO01788 (Fastow Depo.); see also CORO1756-58 (Fastow

Depo.). Fastow elaborated:

Well, Enron had a problem in that its — the results it

would otherwise have published from just its business

operations were usually insufficient in order for Enron to

'§ CORO1177 (Ex. 50028); CORO1078 (Ex. 11664); COR00020 (ML

Summary Judgment Ex. 5). Documents cited herein appear in the Record

of Appeal (“R”) before the Fifth Circuit in the Regents v. Credit Suisse

First Boston, No. 06-20856, and are cited by giving the volume and the

Fifth Circuit page number, e.g., “8R:36721.” In addition, documents cited

as “COR” refer to documents submitted and attached to Appellees’

Motion to Correct Omissions from the Transmitted Record also filed in

Regents v. Credit Suisse First Boston, No. 06-20856 (Sth Cir.).

12

maintain its investment grade credit rating or to meet its

earnings targets.

And we were looking [sic] with banks who could help

us solve this problem, meaning doing transactions that

would, as we described it internally, fill the gap between

what was really happening inside Enron and what — the

way we wanted Enron to appear to the outside world.

CORO01754 (Fastow Depo.). These contrivances and subter-

fuges reportedly deceived Enron’s auditors, who testified that

had they not been misled by the Banks, they would not have

approved accounting for numerous transactions or provided

audit certifications.’

But the Enron majority concluded that, even assuming this

was all true, “the banks only aided and abetted that fraud,”

and the “banks’ participation in the transactions, regardless of

the purpose and effect of those transactions, did not give rise

to primary liability under §10(b).” Enron, 482 F.3d at 386,

390. To reach this result, the Fifth Circuit majority read

this Court’s precedents as “narrowly defining the scope of

‘fraud’ in the context of securities” (id. at 387), and it opted

for a “/sJtrict construction of §10(b)” and a “limited inter-

pretation of the words of §10,” to preclude liability under the

rubric of “deceptive acts” or “scheme.” Jd. at 392-93.

With understatement, the majority noted the Banks’ con-

duct was “‘hardly praiseworthy,’” id at 394 n.2, admitting

that its “interpretation of §10(b) could have gone in a dif-

ferent direction and . . . established liability for the actions the

banks are alleged to have undertaken . . . [as] one of our sister

circuits — the Ninth [Circuit] — believes that it did.” /d. at

393. Acknowledging that “former Enron shareholders who

have lost billions of dollars in a fraud” would find the result

at odds “with notions of justice and fair play,” the Fifth

'? arthur Andersen (“AA”) auditors, Thomas Bauer, Michael Odom,

Patty Grutzmacher and John Stewart all testified that had they known the

truth about the transactions, AA would not have approved the accounting.

13

Circuit denied the victims of this notorious fraud even a

chance to prove their §10(b) case on the merits — so as to

avoid “opening the floodgates for nearly unlimited and

frequently unpredictable liability for secondary actors in the

securities markets.” Jd.

Styled a “concurrence,” Judge Dennis’s opinion is in sub-

stance a dissent from the Enron majority’s analysis on these

points. He disagreed with “the majority’s cramped interpre-

tation of the statutory language of section 10(b),” that “im-

munizes a broad array of undeniably fraudulent conduct from

civil liability under Section 10(b), effectively giving secon-

dary actors license to scheme with impunity, so long as they

keep quiet.” Jd. at 394. Recognizing that “the majority’s

[decision] is strictly a question about the substantive reach of

Section 10(b)” (id. at 397), he stated its “narrow interpre-

tation of Section 10(b)” ignored this Court’s mandate to

construe “the disputed statutory language ‘not technically and

restrictively, but flexibly to effectuate its remedial purposes.’

SEC v. Zandford, 535 U.S. 813, 819 (2002).” Enron, 482

F.3d at 399-400. Judge Dennis concluded (id. at 400-01):

I see no basis for the majority opinion’s strict, narrow

reading, and I agree with the district court, the Ninth

Circuit [in Simpson], Judge Kaplan [in Parmalat), and

the SEC that Section 10(b)’s prohibition on directly or

indirectly employing any “deceptive device or contriv-

ance” can reach secondary actors who, with scienter,

engage in fraudulent transactions that are used to inflate

an issuer’s financial results. See Simpson, 452 F.3d at

1050 (“If a defendant’s conduct or role in an illegitimate

transaction has the principal purpose and effect of creat-

ing a false appearance of fact in the furtherance of

a scheme to defraud, then the defendant is using or

employing a deceptive device within the meaning of

§10(b)”); Enron, 2006 U.S. Dist. LEXIS 43146, at *167-

74 (adopting SEC view “that a deceptive act includes a

transaction whose principal purpose and effect is to

create a false appearance of revenues, which can be

14

accomplished by acts as well as by words”) (internal

quotation marks omitted); Parmalat, 376 F. Supp. 2d at

502-03.

A central question, of course, is whether the words “use or

employ . . . any manipulative or deceptive device or contriv-

ance” in §10(b) may encompass the use or employment of a

“scheme . . . to defraud” prohibited by Rule 10b-5(a) — thus

creating liability for engaging in a scheme to defraud (assum-

ing scienter and all the other elements of §10(b) liability are

present) — or whether they are limited to misstatements of

fact. The Enron majority chose the latter interpretation, as

“the rule may not be broader than the statute” and the “district

court’s definition of ‘deceptive device’ [to include fraudulent-

scheme liability] thus sweeps too broadly.” Enron, 482 F.3d

at 390. Yet, holding that §10(b)’s language is to be inter-

preted and applied in a “flexible” manner to effectuate its

“remedial purposes” (not “narrowly” or in a “strict” manner

as the Enron majority said), Zandford also expressly states

“[t]he scope of Rule 10b-5 is coextensive with the coverage of

$10(6),” 535 U.S. at 816 n.1, foreclosing any conclusion that

Rule 10b-5’s “scheme to defraud” language is beyond the

scope of §10(b).”°

The Enron majority claimed that the need for “certainty

and predictability” for “good-faith financial professionals

who are attempting to avoid liability” justified its decision.

Enron, 482 F.3d at 386, 392. Amicus agrees that “‘certainty

and predictability’” are desirable. Central Bank, 511 U.S.

The SEC had alleged the defendant “‘engaged in a scheme to

defraud,”” via a “complaint describ[ing] a fraudulent scheme” and “was

... able to carry out his fraudulent scheme without making an affirmative

misrepresentation.” Id at 820. His “conduct without more” was held a

violation of §10(b), as “neither the SEC nor this Court has ever held that

there must be a misrepresentation about the value of a particular security

in order to run afoul of the Act.” Jd Zandford supports liability for know-

ingly engaging in a fraudulent scheme, even if no affirmative misstatement

is made.

15

at 188 (quoting Pinter v. Dahl, 486 U.S. 622, 652 (1988)).

Market actors like banks should know that if they use or

employ a deceptive device or contrivance, while engaging in

a scheme to defraud, they will certainly and predictably face

liability under §10(b). Such certainty and predictability would

further the deterrent purpose of the law, preventing fraud, as

banks (and other market participants) are disincentivized to

engage in misconduct. Investors are entitled to certainty and

predictability too — they should be able to invest their capital

in our markets knowing that fraudulent schemes are unlawful

and that if they are victimized by deliberately deceptive

misconduct they will at least have access to the federal courts

to pursue a remedy. That is the kind of certainty and pre-

dictability we need to assure the integrity of our markets and

to protect investors — the real purpose of our securities laws.

The tortured reasoning of the decision below and of the

Enron majority are an injustice to the victims of fraud, setting

an incorrect and dangerous precedent that misinterprets §10(b)

and Rule 10b-5, misapplies Central Bank, ignores Zandford,

and undermines the broad protections that §10(b)/Rule 10b-5

were meant to provide America’s investors from decep-

tive devices and contrivances — including fraudulent schemes.

SUMMARY OF ARGUMENT

The decision below conflicts with the position of the SEC,

adopted by the Ninth Circuit in Simpson, and by the Enron

district court. It is, moreover, wrong. When it followed the

decision below in this case, the Fifth Circuit majority in

Enron admitted that the SEC disagreed with its “narrow” and

“strict construction” of §10(b), and that its decision “could

have gone in a different direction,” had it been true to

§10(b)’s text. Enron, 482 F.3d at 387, 393. Applying that

text, this Court’s precedents strongly support scheme liability.

See, e.g., Zandford, 535 U.S. at 820; Affiliated Ute Citizens v.

United States, 406 U.S. 128, 151-53 (1972); Superintendent

of Ins. v. Banker’s Life & Casualty Co., 404 U.S. 6 (1971).

16

Circuit court decisions support scheme liability.24 So do

many recent district court decisions.” Those who engage in

schemes to defraud investors by executing sham transactions

to falsify a company’s financial results or hide its debt prop-

erly face primary liability under §10(b) and Rule 10b-S.

ARGUMENT

I. THE DECISION BELOW AND ENRON DEPART

FROM THE STATUTORY TEXT

Liability exists under §10(b) for any person who (with

scienter) engages in falsifying the financial statements of a

public company, whether or not that person independently

2! See Cooper v. Pickett, 137 F.3d 616, 620 (9th Cir. 1997) (scheme

liability exists “as long as each defendant committed a . . . deceptive act in

furtherance of the scheme”); SEC v. U.S. Envtl., Inc., 155 F.3d 107, 112

(2d Cir. 1998) (defendant a primary violator if he “‘participated in the

fraudulent scheme,” noting “lawyers, accountants, and banks who engage

in fraudulent or deceptive practices at their clients’ direction [are] primary

violator[s]”); Competitive Assocs., Inc. v. Laventhol, Krekstein, Horwath

& Horwath, 516 F.2d 811, 814-15 (2d Cir. 1975) (“Not every violation of

the anti-fraud provisions of the federal securities law can be, or should be,

forced into a category headed ‘misrepresentations’ or ‘non-disclosures.’

Fraudulent devices, practices, schemes, artifices and courses of business

are also interdicted by the securities laws.”), Blackie v. Barrack, 524 F.2d

891, 904 n.19 (9th Cir. 1975) (“Rule 10b-5 liability is not restricted solely

to isolated misrepresentations or omissions; it may also be predicated on a

‘practice, or course of business which operates. . . as a fraud... .””);

Richardson v. MacArthur, 451 F.2d 35, 40 (10th Cir. 1971) (“[AJil fraudu- ~~

lent schemes in connection with the purchase and sale of securities are

prohibited”).

” See, e.g., Parmalat, 376 F. Supp. 2d at 504; In re Lernout & Hauspie

Sec. Litig., 236 F. Supp. 2d 161, 173 (D. Mass. 2003); In re Initial Pub.

Offering Sec. Litig., 241 F. Supp. 2d 281, 381-82 (S.D.N.Y. 2003); Quaak

v. Dexia, S.A., 357 F. Supp. 2d 330, 342 (D. Mass. 2005); In re Global

Crossing, Lid. Sec. Litig., 322 F. Supp. 2d 319, 336-37 (S.D.N.Y. 2004);

SEC v. Hopper, No. H-04-1054, 2006 U.S. Dist. LEXIS 17772, at *34-

*42 (S.D. Tex. Mar. 24, 2006).

17

makes a false statement himself, so long as the actor uses or

employs a manipulative or deceptive device or contrivance.

This is the test mandated by the express language of §10(b)

and Rule 10b-5.

The standard applied by the Eighth Circuit below, and by

the Fifth Circuit in Enron, departs radically from the statutory

text’s natural meaning. The Enron majority even chided the

district court in that case for construing §10(b)’s use of the

word “deceptive” in line with its ordinary meaning, explain-

ing that it is only “by ascribing natural, dictionary definitions

to the words of the [statute and] rule, that the district court

and likeminded courts have gone awry.” Enron, 482 F.3d at

387. The Enron majority ruled that “defining ‘deceptive’ by

referring to the same dictionary the [Supreme] Court used

to define ‘device,’ a [sic] — the approach taken by the court

in Parmalat, 376 F. Supp. 2d at 502, and approvingly cited by

the district court... is improperly to substitute the authority

of the dictionary for that of the Supreme Court.” Enron, 482

F.3d at 389.

Yet this Court holds that statutory language generally must

be interpreted in accord with its ordinary meaning.”’ Section

§10(b)’s words, in particular, must be accorded their “com-

monly accepted meaning.” Ernst & Ernst v. Hochfelder, 425

U.S. 185, 198-99 (1976).

The Fifth and Eighth Circuits both misconstrue this Court’s

precedents concerning the term “deceptive.” According to

this Court’s precedents, §10(b)’s prohibition of “any manipu-

lative or deceptive device or contrivance” necessarily encom-

passes a “scheme to defraud.” This Court used Webster's

* Pasquantino v. United States, 544 U.S. 349, 356 (2005) (“*When

interpreting a statute, we must give words their ordinary or natural mean-

ing.’”); Smith v. United States, 508 U.S. 223, 228 (1993) (“When a word

is not defined by statute, we normally construe it in accord with its

ordinary or natura] meaning.”).

18

International Dictionary (2d ed. 1934) to give content to

§10(b)’s terms in Hochfelder, 425 U.S. at 188 & nn.20-21.

Hochfelder referred to dictionary definitions of §10(b)’s

words to state that a “device” is “‘[t]hat which is devised, or

formed by design; a contrivance; an invention; project;

scheme; often, a scheme to deceive; a stratagem; an artifice.””

Id. at 199 n.20. The Court also found that a “contrivance”

means “‘a scheme, plan, or artifice,” again quoting Webster’s.

Id.; see also Aaron v. SEC, 446 U.S. 680, 696 n.13 (1980).

Clearly, a “scheme” to deceive investors is encompassed

in the express language of §10(b), according to the natural,

commonly understood meaning of the words of §10(b). Thus

Rule 10b-5 — adopted by the SEC to implement §10(b) —

properly makes it unlawful for any person “directly or

indirectly . . . to employ any device, scheme, or artifice to

defraud,” as well as “[t]o make any untrue statement[s],” or

to “engage in any act, practice, or course of business which

operates . . . as a fraud or deceit upon any person.” 17

C.F.R. §240.10b-5.

The Fifth Circuit concluded in Enron that “what the banks

are alleged to have done, namely engage in transactions else-

where that gave a misleading impression of the value of

Enron securities that were already on the market,” is beyond

§10(b)’s reach. Enron, 482 F.3d at 391. The Banks’ conduct,

executed with the purpose and effect of deliberately creating

“a misleading impression of the value of Enron securities”

(id.), was held not “deceptive” within the meaning of a statute

that by its express terms was designed to reach “any manipu-

lative or deceptive device or contrivance” employed by “any

person,” whether “directly or indirectly.” 15 U.S.C. §78j(b).

The majority frankly acknowledged that nothing in §10(b)

compelled this odd result (Enron, 482 F.3d at 393):

We acknowledge that the courts’ interpretation of §10(b)

could have gone in a different direction and might have

established liability for the actions the banks are alleged

19

to have undertaken. Indeed, one of our sister circuits —

the Ninth [Circuit] — believes that it did.

Nothing in this Court’s decisions suggests that courts may

ignore the ordinary meaning of the statute’s words to immu-

nize those who deliberately engage in deceptive acts or use

contrivances in scheming to mislead investors. Quite the

contrary, Central Bank held that “the text of the 1934 Act

does not itself reach those who aid and abet a §10(b)

violation,” and that this “conclusion resolves the case.” 511

U.S. at 177. If the statutory text thus controls then those who

engage in deliberately deceptive acts as part of a scheme to

mislead investors must be primary violators of §10(b), not

mere aiders and abettors.

Yet the Enron majority and the court below both rejected

§10(b)’s plain meaning. The pertinent text states: “It shall be

unlawful for any person, directly or indirectly . . . to use

or employ . . . any . . . deceptive device or contrivance.” 15

U.S.C. §78j(b). These words cannot sensibly be limited to

prohibiting only misstatements. Even under the common law

— which the securities laws were meant to enlarge — decep-

tion included misleading conduct and active concealment.

The common law of deceit and of market manipulation con-

temporaneous with the 1934 Act’s enactment clearly incorpo-

rated this principle.?* Dean William J. Prosser explained:

* The common law of fraud and deceit saw deception in any conduct

designed to mislead another: “The gist of the action is fraudulently pro-

ducing a false impression upon the mind of the other party; and, if this

result is accomplished it is unimportant whether the means of accom-

plishing it are words or acts of the defendants.” Stewart v. Wyoming

Cattle Ranche Co., 128 U.S. 383, 388 (1888); accord, e.g., United States

v. Colton, 231 F.3d 890, 899-900 (4th Cir. 2000) (following Stewart);

United States v. Brown, 5 F. Supp. 81, 89 (S.D.N.Y. 1933), aff'd 79 F.2d

321 (2d Cir. 1935); Leonard v. Springer, 64 N.E. 299, 301 (Ill. 1902).

* See Brown, 5 F. Supp. at 84-89; A.A. Berle, Stock Market Manipula-

tion, 38 Colum. L. Rev. 393, 394-97 (1938); A.A. Berle, Liability for

Stock Market Manipulation, 31 Colum. L. Rev. 264, 267-71 (1931).

20

The representation which serves as the foundation for an

action of deceit may consist of words or conduct. Any

active concealment of the truth, by words or conduct

creating a false impression or removing an opportunity

to discover the facts, is treated as the equivalent of a

representation that such facts are not true.

William J. Prosser, Handbook of the Law of Torts §86, at 720

(1st ed. 1941).”° And this Court adheres to “the general rule

that a common law term in a statute comes with a common

law meaning absent anything pointing another way.””’

Those who engage in transactions that are deceptive —

both in the sense that they gave the false appearance of being

** The Restatement is to the same effect: “‘Misrepresentation’ is used

in this Chapter to denote not only words spoken or written but also any

other conduct which amounts to an assertion not in accordance with the

truth. Thus, words or conduct asserting the existence of a fact constitute a

misrepresentation if the fact does not exist.” Restatement of Torts, §525,

cmt. b (1938); accord Restatement (Second) of Torts §525, cmt. b (1979).

“A misrepresentation may be expressed by acts and conduct as well as in

words. A falsehood may be expressed by deeds, acts, conduct, or artifice,

as well as in words or assertions; deceptive conduct is equivalent to verbal

misrepresentation. A misrepresentation may consist of a combination of

conduct and concealment or conduct and language or solely of conduct.”

37 C.J.S. Fraud §12 (2007).

7” Safeco Ins. Co. of Am. v. Burr, No. 06-84, U.S. _, 2007 US.

LEXIS 6963, at *20-*21 (U.S. June 4, 2007); accord Neder v. United

States, 527 U.S. 1, 21-22 (1999). Given “the common-law roots of the

securities fraud action,” Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 344

(2005), of course, “it would be highly inappropriate to construe the Rule

10b-5 remedy to be more restrictive in substantive scope than its common

law analogs.” Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033,

1044 (7th Cir. 1977). “Indeed, an important purpose of the federal securi-

ties statutes was to rectify perceived deficiencies in the available common-

law protections by establishing higher standards of conduct in the securi-

ties industry,” Herman & MacLean v. Huddleston, 459 U.S. 375, 389

(1983), and private actions under §10(b), in particular, “are in part de-

signed to add to the protections provided investors by the common law.”

Basic, 485 U.S. at 245 n.22.

21

something other than what they were, and in the sense that

they were designed to (and did) effect a fraud on investors —

should be liable under §10(b). Enron provides a clear case in

point. The Banks were not only aware of the deception —

they actively engaged in the deceptive transactions at its core

and thereby committed an active misrepresentation of Enron’s

condition, and concealment of its debt. Thus, in effect, the

Banks made a false representation. And, because their decep-

tion was aimed squarely at the market, the Banks should be

found primarily liable to market participants, even though the

deception was communicated to the market through Enron.

This Court should not adopt a rule that protects them from

liability.

Opinions of the Ninth Circuit in Simpson, Judge Harmon in

Enron, and Judge Kaplan in Parmalat, all show that courts

can draw a careful distinction between primary and secondary

liability in this context. In Parmalat, Judge Kaplan dealt with

secondary actors (banks) engaging in conduct similar to that

at issue in Enron:

In this case, the complaint alleges that the banks’

actions in connection with the relevant transactions actu-

ally and foreseeably caused losses in the securities mar-

kets. The banks made no relevant misrepresentations to

those markets, but they knew that the very purpose of

certain of their transactions was to allow Parmalat to

make such misrepresentations. In these circumstances,

both the banks and Parmalat are alleged causes of the

losses in question. So long as both committed acts in

violation of statute and rule, both may be liable.

This analysis is not an end run around Central Bank.

If a defendant has committed no act within the scope of

Section 10(b) and Rule 10b-5 — as in fact was the case

in Central Bank — then liability will not arise on the

theory that that defendant assisted another in violating

the statute and rule. But where, as alleged here, a

financial institution enters into deceptive transactions as

22

part of a scheme in violation of Rule 10b-S(a) and (c)

that causes foreseeable losses in the securities markets,

that institution is subject to private liability under

Section 10(b) and Rule 10b-5.

Parmalat, 376 F. Supp. 2d at 509-10.

To reject this view requires the statute’s words to be

reinterpreted: “Directly or indirectly” must be reinterpreted

to mean only “directly,” since only the maker of a false

statement (i.e., the “direct” actor) can be liable. “Use or

employ” — the verbs the statute uses in making it unlawful to

“use or employ any device or contrivance” — plainly suggest

conduct or the operation of a scheme, not just the making of

misrepresentations. The plain words “device or contrivance”

contradict any limitation on the thing that is “used or

employed” to statements of fact. Yet the decision below in

this case requires reading §10(b) as follows: “It shall be

unlawful for any person, directly /not indirectly] to make [not

use or employ] . . . any deceptive statement [not device or

contrivance ].”

The Enron majority said it departed from a natural reading

of the statute’s words (Enron, 482 F.3d at 387), because

“(t]he Supreme Court has defined ‘device’ by referring to a

dictionary but has pointedly refused to define ‘deceptive’ in

any way except through caselaw,” which the majority con-

strued as deviating widely from the ordinary meaning of what

is deceptive. Jd. at 389. Specifically, the majority construed

this Court’s insider-trading decisions, Chiarella v. United

States, 445 U.S. 222, 234-35 (1980), and United States v.

O’Hagan, 521 U.S. 642, 655 (1997), as creating a general

rule that however deceptive a misleading device or contriv-

ance may be in fact, even an inherently misleading “device,

such as a scheme, is not ‘deceptive’ unless it involves breach

of some duty of candid disclosure.” Enron, 482 F.3d at 389.

“Enron had a duty to its shareholders,” it reasoned, “but the

banks did not.” /d. at 390. Thus, the Banks’ conduct in

23

engaging in contrived transactions to hide Enron’s debt and

inflate its earnings in order to mislead investors could not be

deemed “deceptive” as that term is used in §10(b).

The Enron majority’s opinion misreads this Court’s prece-

dents. Chiarella’s discussion of duty assumes a claim based

on a failure to speak: “This case concerns the legal effect of

the petitioner’s silence.” 445 U.S. at 226. In an insider-

trading case like Chiarella, the claim of fraud is grounded in

an insider’s failure to make required disclosures in connection

with a specific securities transaction. Chiarella and O’Hagan

did not at all address whether deliberately deceptive conduct

can qualify as a deceptive device under §10(b).

“Silence, absent a duty to disclose, is not misleading under

Rule 10b-5,” this Court observed in Basic, 485 U.S. at 239

n.17. In contrast, this case and Enron involve the legal effect

not of third parties’ silence, but of their deceptive conduct.

The investors’ claims in both cases are grounded not in

alleged silence in the face of a duty to speak, but upon the

fact that the defendants deliberately engaged in conduct to

mislead investors by affirmatively taking steps to distort an

issuer’s financial statements — conduct which the Enron

majority recognized actually inflated the value of Enron’s

securities trading in the market.”

8 Enron, 482 F.3d at 382-83. The relevant duty thus is the duty not to

engage in conduct that violates the statute, which forbids “any person”

from engaging in the specified “manipulative or deceptive” conduct. As

the Enron district court noted:

[TJhe requisite duty is not a duty to disclose, but . . . “the duty not to

engage in a fraudulent ‘scheme’ or ‘course of conduct’ [that] could

be based primarily on an omission.”

Enron, 2006 U.S. Dist. LEXIS 43146, at *102. The statute prohibits “any

person” from employing “any manipulative or deceptive device or con-

trivance” “in connection with the purchase or sale of any security.” 15

U.S.C. §78j(b). The statute by its very plain terms reaches any person

engaged in “a scheme to misrepresent the publicly reported revenues of a

company” because “all participants may be viewed as having acted in

24

Section 10(b) does not even speak in terms of statements

and omissions. It obviously was designed to cover deceptive

conduct — as well as deceptive statements and omissions —

by making it unlawful “for any person, directly or indirectly,

... to use or employ . . . any manipulative or deceptive device

or contrivance” proscribed by the SEC. 15 U.S.C. §78j(b).

Rule 10b-5 addresses misleading statements and omissions in

subsection (b), but in subsections (a) and (c) it imposes a duty

not to engage in devices or schemes (subsection (a)) or acts,

practices or courses of business conduct (subsection (c)) that

would “operate as a fraud” on any person. To say that there

can be no fraud absent a duty to speak would collapse (a) and

(c) into Rule 10b-5(b)’s rule against misleading statements

and omissions.

Il. THE LIABILITY STANDARD FRAMED BY

THE SEC AND ADOPTED IN SIMPSON

COMPORTS WITH STATUTORY TEXT AND

WITH THIS COURT’S PRECEDENTS

While the decision below, and the Enron majority, both

impermissibly distort §10(b)’s language to do away with

scheme liability, the SEC’s carefully crafted test, adopted by

the Ninth Circuit in Simpson and by the district court in

Enron, is wholly consistent with this Court’s decision in

Central Bank. Aiding-and-abetting liability was barred in

Central Bank because the words “aid and abet” are not in the

statute or rule, and also because aiding-and-abetting liability

mighi be imposed on one who merely assisted in some way

another person’s violation, without doing anything manip-

ulative or deceptive itself. An aider and abettor could be held

liable for violating §10(b) despite doing nothing prohibited by

§10(b). By contrast, the prohibition against engaging in

connection with the purchase or sale of securities.” Simpson, 452 F.3d at

1051. In Enron, in Parmalat, the “banks’ actions in connection with the

relevant transactions actually and foreseeably caused losses in the securi-

ties markets.” Parmalat, 376 F. Supp. 2d at 509.

25

deceptive conduct or a scheme to defraud flows from the

statute’s text, imposing liability when an actor, with scienter,

does something prohibited by §10(b): use or employ a

manipulative or deceptive device or contrivance. Petitioner’s

theory of liability is true to Central Bank and to the con-

trolling statute’s words.

Central Bank did not immunize bankers from liability for

engaging in complex securities frauds. It recognized: “The

absence of §10(b) aiding and abetting liability does not mean

that secondary actors in the securities markets are always

free from liability under the securities Acts. . . . In any com-

plex securities fraud, moreover, there are likely to be multiple

violators ... .” Central Bank, 511 U.S. at 191. A scheme

often will involve multiple actors, and investors are entitled to

allege “that a group of defendants acted together to violate the

securities laws, as long as each defendant committed a

manipulative or deceptive act in furtherance of the scheme.”

Cooper, 137 F.3d at 624.”°

Central Bank noted its reasoning was “confirmed” by the

fact that to accept the plaintiffs’ aiding-and-abetting argument

would impose §10(b) liability “when at least one element

critical for recovery” was absent, i.e., reliance on the defen-

dant’s conduct. “Were we to allow the aiding and abetting

action proposed in this case, the defendant could be liable

? In Central Bank, the defendant bank had no commercial relation-

ships with the municipal entity involved, was not its investment bank, was

not an underwriter of its securities, and issued no analyst reports about the

issuer. It took no affirmative act that could have affected the trading price

of the municipal bonds in issue — for which there was no trading market.

Clearly, that is a significantly different fact pattern from the allegations

against the Banks in Enron, which engaged in repeated transactions of an

inherently deceptive nature with Enron, including contrivances, sham en-

tities and secret no-loss/take-out guarantees — bogus transactions de-

signed to directly distort Enron’s financial statements as filed with the

SEC and distributed to the investment community — all of which

inevitably impacted the trading price of Enron’s securities.

26

without any shewing that the plaintiff relied upon the aider

and abettor’s statements or actions.” Central Bank, 511 U.S.

at 180. Allowing plaintiffs to “circumvent the reliance require-

ment would disregard the careful limits on 10b-5 recovery as

mandated by our earlier cases.” Central Bank, 511 U.S. at

180. This Court cited Basic, 485 U.S. 224, which held that

reliance is satisfied if fraudulent acts affect the price at which

securities trade. See Central Bank, 511 U.S. at 180.

But in this case, and in Enron, third parties’ deceptive con-

duct did operate to inflate the prices of publicly traded securi-

ties. Indeed, the Enron majority acknowledged “the factual

probability tha: the market relied on the banks’ behavior

and/or omissions,” and that what the banks did was to “en-

gage in transactions . . . that gave a misleading impression of

the value of Enron securities that were already on the mar-

ket.” Enron, 482 F.3d at 383, 391. The reliance element is

satisfied in a fraud-on-the-market case when securities trad-

ing in an open-and-developed market are thus affected. See

Basic, 485 U.S. at 241-49; see also Parmalat, 376 F. Supp.

2d at 505-06.

A long line of this Court’s decisions, moreover, recognizes

that deceptive conduct violates §10(b). In Superintendent

of Ins., 404 U.S. 6, a unanimous Court upheld a complaint

involving a “fraudulent scheme” involving the sale of securi-

ties, explaining: “7here certainly was an ‘act’ or ‘practice’

within the meaning of Rule 10b-5 which operated as ‘a fraud

or deceit’ on Manhattan, the seller of the Government bonds.”

Superintendent of Ins., 404 U.S. at 9. This Court emphasized:

“We believe that §10(b) and Rule 10b-5 prohibit all

fraudulent schemes in connection with the purchase or

sale of securities, whether the artifices employed involve

a garden type variety of fraud, or present a unique form

of deception. Novel or atypical methods should not pro-

vide immunity from the securities laws.”

27

Id. at 11 (quoting A.T. Brod & Co. v. Perlow, 375 F.2d 393,

397 (2d Cir. 1967)).

In Affiliated Ute, the Court observed that “the second sub-

paragraph of the rule specifies the making of an untrue state-

ment of a material fact and the omission to state a material

fact,” but held that “[t}he first and third subparagraphs are not

so restricted.” 406 U.S. at 152-53. Thus, the defendants

violated Rule 10b-5 by engaging in “a ‘course of business’ or

a ‘device, scheme, or artifice’ that operated as a fraud,”

though they had never themselves said anything that was

false or misleading. Jd at 153. “[{TJhe 1934 Act and its

companion legislative enactments,” this Court held, were

designed “‘to achieve a high standard of business ethics in the

securities industry.”” Jd. at 151. “Congress intended securi-

ties legislation enacted for the purpose of avoiding frauds to

be construed ‘not technically and restrictively, but flexibly to

effectuate its remedial purposes.”” Jd.

In Hochfelder, this Court noted that a manipulative or

deceptive “device,” by definition, includes “a scheme to

defraud.” Hochfelder, 425 U.S. at 189 n.20. A scheme, this

Court elaborated in Aaron, is “‘[a] plan or program of some-

thing to be done.””*® Indeed, a “scheme to defraud” encom-

passes any “plan designed or concocted for perpetrating a

fraud.” Ballentine’s Law Dictionary 1142 (3d ed. 1969). It

has long included any scheme to defraud investors by causing

securities to trade at fraudulently inflated prices; when §10(b)

was enacted such conduct already was an unlawful “scheme

to defraud” under the mail-fraud statute.*' Today it is called

*® Aaron, 446 U.S. at 696 n.13 (“Webster’s International Dictionary

(2d ed. 1934) defines . . . ‘scheme’ as ‘[a] plan or program of something

to be done; an enterprise; a project; as a business scheme(, or a} crafty,

unethical project . . . ."”). To “scheme” is “[t]o form plans or designs; to

devise intrigue.” Webster's International Dictionary 2234 (2d ed. 1934).

*! In Harris v. United States, 48 F.2d 771 (9th Cir. 1931), for example,

“[t}he fraudulent scheme charged . . . was one for the sale of [a mining

28

a “fraud on the market,” actionable under §10(b). See Basic,

485 U.S. at 241-47; Lipton v. Documation, Inc., 734 F.2d

740, 744-47 (11th Cir. 1984). Every person who intentionally

engages in such a “scheme” to defraud by using a “manipulat-

ive or deceptive device or contrivance” is thus a primary

violator of §10(b).

In O’Hagan, this Court held that liability under §10(b) does

not require a defendant to speak; because §10(b) prohibits

““any manipulative or deceptive device or contrivance”” in

contravention of SEC rules outlawing “any deceptive device,”

whether or not the defendant spoke. O’Hagan, 521 U.S. at

651.

In Zandford, 535 U.S. 813, this Court repeatedly cited with

approval its seminal “fraudulent scheme” case, Superintendent

of Ins., and reversed dismissal, making the following key points:

e “The scope of Rule 10b-5 is coextensive with the

coverage of §10(b)... .”

e “[Njeither the SEC nor this Court has ever held that

there must be a misrepresentation about the value of a

particular security” to violate §10(b).

e Allegations that defendant “engaged in a fraudulent

scheme” or “‘course of business’ that operated as a

fraud or deceif” stated a §10(b) claim. Zandford, 535

U.S. at 816 n.1, 820-21.

Central Bank clearly — but merely — stands for the propo-

sition that no aiding-and-abetting liability exists under the

1934 Act because neither §10(b) nor Rule 10b-5 contain

“aiding and abetting” language. The decision in Central

company’s} corporate stock . . . by the manipulation of tthe price of the

stock on the [stock exchanges] and the circulation of failse reports con-

cerning the mine through the mails.” /d at 774. “In fact, the whole

scheme centered around the establishment of an alleged stock exchange

value which is in fact wholly fictitious.” /d at 775; see also Brown, 5 F.

Supp. at 84-89; Berle, Stock Market Manipulation, supra 0.25, at 395-97.

29

Bank is quite narrow. By contrast, the language of §10(b) and

Rule 10b-5 is broad.

That scheme liability survives Central Bank is confirmed

by Congress’s comprehensive revision of the 1934 Act in

1995, with the Private Securities Litigation Reform Act of

1995 (“PSLRA”), Pub. L. 104-67, 109 Stat. 737 (1995). Just

a year after Central Bank, and its statement that “[i]n most

complex cases there are likely to be multiple violators,” 511

U.S. at 191, Congress substantially revised the law governing

the §10(b) private right of action, including the rules for joint-

and-several liability when multiple actors engage in a fraudu-

lent scheme. 15 U.S.C. §78u-4(f). Congress provided that

proportionate liability is the general rule, but that joint-and-

several liability applies to all who either (i) make a false

statement “with actual knowledge” of its falsity or (ii) other-

wise engage in “conduct with actual knowledge of the facts

and circumstances that make the conduct . . . a violation

of the securities laws.” 15 U.S.C. §78u-4(f)(10)(A)(ii). This

“conduct” language would be superfluous if only the indi-

vidual actor making a statement could be held liable under

§10(b).

fil. THE FACTS IN ENRON SHOW THAT A

CLEAR DISTINCTION MAY BE DRAWN

BETWEEN PRIMARY LIABILITY BASED ON

DECEPTIVE CONDUCT AND MERE AIDING

AND ABETTING

Enron’s facts show that a clear distinction may be drawn

between mere aiding and abetting and primary conduct de-

signed to mislead. The fraud in that case consisted of hiding

Enron’s debt and executing sham transactions to falsify

Enron’s financial results. The Banks that contrived and

executed those transactions to hide debt and to generate

phony financial results engaged in conduct that was intended

— by them — to mislead investors.

30

In Enron many of the bank transactions were completely

illusory, often with secret, no-loss guarantees or take-out

promises, devoid of any economic substance. Their only pur-

pose was to distort Enron’s financial statements. And they

were executed by major players in the securities markets.

Enron involves the alleged misconduct of banks — major

actors in our nation’s financial markets which Central Bank

identified as secondary actors who “may be liable as primary

violators under Rule 10b-5 . . . in any complex securities

fraud [where] there are likely to be multiple violators.”

Central Bank, 511 U.S. at 191. The securities acts were

passed in large part to remedy the misconduct of the Wall

Street banks occurring in the 1920s, as documented by the

Pecora Hearings. See Francis Pecora, Wall Street Under

Oath: The Story of Our Modern Money Changers (1939).

Such banks are financial sophisticates, operating in the heart

of our financial markets — and uniquely positioned to

influence the apparent value of the securities of public

public companies in “structured fimance” transactions

specifically intended to impact a company’s reported finan-

cial condition, selling the company’s securities to investors,

and issuing analyst reports recommending purchase of the

company’s stock — all conduct that can directly impact the

company’s stock price — is something that carries with it the

potential for substantial harm to investors when banks use or

employ manipulative or deceptive devices or contrivances.

Such conduct is subject to the anti-fraud provisions of the

1934 Act.

CONCLUSION

Section 10(b)’s broad proscription reaches conduct under-

taken with the principal purpose and effect of misleading a

company’s investors and creditors.

Respectfully submitted,

WILLIAM S. LERACH

(Counsel of Record)

PATRICK J. COUGHLIN

HELEN J. HODGES

BYRON S. GEORGIOU

ERIC ALAN ISAACSON

SPENCER A. BURKHOLZ

JOSEPH D. DALEY

LERACH COUGHLIN STOIA GELLER

RUDMAN & ROBBINS LLP

655 West Broadway, Suite 1900

San Diego, CA 92101

(619) 231-1058

Counsel for Amicus Curiae

The Regents of The University of California

June 11, 2007