Enron Judge Rejects Efforts By Bankers, Lawyers, and Accountants
To Be Dismissed From Shareholder Class Action - March 5, 2004

March 5, 2003

In a ground-breaking decision, a federal judge in Houston ruled that banks, law firms and accountants that helped put together the off-the-book partnerships Enron used to hide losses and boost earnings could be sued for securities fraud. U.S. District Judge Melinda Harmon denied requests by J.P. Morgan, Chase, Merrill Lynch & Co., Barclays, Citigroup, Credit Suisse First Boston and CIBC to be dismissed from plaintiff's securities class action lawsuit. Also denied were the motions of Enron's law firm, Vinson & Elkins, and its auditor, Arthur Andersen. See In re Enron Corp. Secs., Derivative & ERISA Litig., 235 F. Supp. 2d 549 (S.D. Tex. 2002).

Judge Harmon ruled that any actor who participates in a scheme to defraud investors can be sued by those vicitimized investors so long as she/he commits a “manipulative act.” Making a false statement – including “substantially participating” in the preparation of false statements – can be a manipulative act. So can insider trading – according to the court in America West (see story on page 1) – by one who neither makes, nor participates in the making of, a false statement. The plaintiff in Enron has alleged substantial amounts of insider trading by Enron's executives (see chart to the right).

Judge Harmon's opinion relied in part on a recent pronouncement from the U.S. Supreme Court recognizing “scheme” liability under the securities laws. In that case, SEC v. Zandford, 535 U.S. 813 (2002), the Supreme Court held that allegations by a plaintiff that a defendant “engaged in a fraudulent scheme” or “course of business that operate[s] as a fraud or deceit” states a claim for securities fraud.

In her opinion, Judge Harmon noted that “[s]ince the passage of the PSLRA with its procedural hurdles and stringent pleading standards … this country has been overwhelmed with corporate scandals that place Congress' goal in enacting the PSLRA in a much wider perspective,” and that “[t]he PSLRA's significance as a protective shield for business must be viewed within the context of the private right of action, granted decades before, to defrauded investors injured by corporate management, auditors, outside counsel and investment bankers.” Enron, 235 F. Supp. 2d at 593.

Judge Harmon set out the clearest standard for interpreting the U.S. Supreme Court's 1994 ruling in Central Bank N.A. v. First Interstate Bank N.A., 511 U.S. 164 (1994), which held that those who intentionally aid or abet another in a securities fraud are not liable to the defrauded investors.

“Nobody has addressed these issues this definitively or this exhaustively,” said William Lerach, lead counsel prosecuting the class action on behalf of lead plaintiff, The Regents of the University of California. “What this means is that Central Bank is going to receive a narrow application going forward, and not an expansive one. This is good for investor protection.”

Judge Harmon ruled that the actions of the defendants crossed the line from normal business practices into manipulative acts undertaken with the intent to defraud. “These transactions were not isolated, one-of-a-kind instances of violations of the statutes, but deliberate, repeated actions with shared characteristics that were part of an alleged common scheme through which Defendants all profited handsomely....” Enron, 235 F. Supp. 2d at 694.

Judge Harmon's decision confirms the validity of plaintiff's legal claims against these important defendants, and keeps in the case defendants with resources to pay substantial compensation to the defrauded class. Lerach said he plans “to focus on the role of the investment banks and their top executives in perpetrating this fraud on investors.”


This article originally appeared in the second quarter 2003 edition of the Corporate Governance Bulletin.