Case 2:03-cv-01500-K0B-TMP Document 1391 Filed 05/27/2008 Page 1 of 41 FILED
2008 May-27 PM 06:43
U.S. DISTRICT COURT
N.D. OF ALABAMA
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF ALABAMA
SOUTHERN DIVISION
In re HEALTHSOUTH CORPORATION )
SECURITIES LITIGATION ) MASTER FILE NO.
) CV-03-BE-1500-C
This Document Relates To: All Actions
)
)
In re HEALTHSOUTH CORPORATION ) CONSOLIDATED CASE NO.
STOCKHOLDER LITIGATION ) CV-03-BE-1501-S
This Document Relates To: All Actions )
)
)
In re HEALTHSOUTH CORPORATION ) CONSOLIDATED CASE NO.
BONDHOLDER LITIGATION ) CV-03-BE-1502-S
This Document Relates To: All Actions )
)
UBS DEFENDANTS' MEMORANDUM IN SUPPORT OF
THEIR RULE 12(C) MOTION FOR JUDGMENT ON
THE PLEADINGS DISMISSING PLAINTIFFS'
SECTION 10(B) "SCHEME TO DEFRAUD" CLAIMS
Case 2:03-cv-01500-KOB-TMP Document 1391 Filed 05/27/2008 Page 2 of 41
Robert J. Giuffra, Jr. W. Michael Atchison (ASB-4005-T75W)
Brian T. Frawley Jay M. Ezelle (AZB-4744-Z72J)
Julia M. Jordan Robin H. Jones (ASB-0769-R51J)
Erin R. Chlopak STARNES & ATCHISON LLP
SULLIVAN & CROMWELL LLP 100 Brookwood Place, Seventh Floor
125 Broad Street Birmingham, Alabama 35209
New York, New York 10004 (205) 868-6000
(212) 558-4000
Counsel for UBS AG, UBS Securities LLC,
Counsel for UBS AG, UBS Securities Howard Cape/c, Benjamin D. Lorello and
LLC, Howard Cape/c, Benjamin D. William C. McGahan
Lorello and William C. McGahan
Helen Gredd
Thomas Fitzpatrick Daniel Gitner
LAW OFFICES OF THOMAS LANKLER SIFFERT WOHL LLP
FITZPATRICK 500 Fifth Avenue
500 Fifth Avenue, 33rd Floor New York, New York 10110
New York, New York 10110 (212) 921-8399
(212) 930-1290
Counsel for William C. McGahan
Counsel for Howard Capek
Robert J. Anello
Richard F. Albert
MORVILLO, ABRAMOWITZ, GRAND,
IASON, ANELLO BOHRER, P.C.
656 Fifth Avenue
New York, New York 10017
(212) 856-6000
Counsel for Benjamin D. Lorello
May 27, 2008
Case 2:03-cv-01500-K0B-TMP Document 1391 Filed 05/27/2008 Page 3 of 41
TABLE OF CONTENTS
Page
PRELIMINARY STATEMENT 1
BACKGROUND 4
A. Plaintiffs' Flawed "Scheme" Theory of Section 10(b)
Liability 4
B. The Misrepresentation Claims 5
C. Regents 6
D. The Supreme Court's Stoneridge Decision 6
STANDARD ON THIS MOTION 9
ARGUMENT 9
I. UNDER STONERIDGE AND REGENTS, JUDGMENT MUST
BE ENTERED FOR UBS ON PLAINTIFFS' "SCHEME"
CLAIMS. 9
A. Stoneridge Rejected, as a Matter of Law, Plaintiffs'
"Scheme" Theory Here. 9
1. Following Stoneridge, There is No "Scheme"
Liability. 9
2. Plaintiffs Cannot Establish Reliance on Any DES
Conduct. 11
3. Plaintiffs' "Scheme" Claims Allege Only Legally
Non-Existent Aider and Abettor Liability. 14
4. Plaintiffs' "Scheme" Claims Against DES Lack
Any Viable Theory of Loss Causation. 15
5. Stoneridge Rejected "Scheme" Liability Based on
the Narrow Scope of the Section 10(b) Private
Right of Action, Not the Particular Services
Provided by a Defendant 17
Case 2:03-cv-01500-K0B-TMP Document 1391 Filed 05/27/2008 Page 4o1 41
B. The "Extremely Persuasive" Regents Decision Remains
Good Law, and Requires Judgment for DES 21
1. Regents Remains a Correct Statement of the Law 21
2. Regents Cannot be Distinguished From the Facts
Alleged Here and Requires Judgment for DES. 23
IL ONCE PLAINTIFFS' "SCHEME" CLAIMS ARE
ELIMINATED, THEIR REMAINING SECTION 10(B) CLAIMS
ALSO ARE DEFICIENT. 27
CONCLUSION 29
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TABLE OF AUTHORITIES
Page (s)
FEDERAL CASES
Avis Budget Group, Inc. v. Cal. State Teachers' Ret. Sys.,
128 S. Ct. 1119 (2008) 21
Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,
511 U.S. 164 (1994) passim
In re Coca-Cola Enters. Inc. Sec. Litig.,
No. 1:06-CV-0275-TWT, 2007 WL 2904160 (N.D. Ga. Oct. 3, 2007) 16
Cordova v. Lehman Bros.,
526 F. Supp. 2d 1305 (S.D. Fla. 2007) 16
Davies Warehouse Co. v. Bowles,
321 U.S. 144 (1944) 20
Davis v. Coca-Cola Bottling Co. Consol.,
516 F.3d 955 (11th Cir. 2008) 9
Dura Pharms., Inc. v. Broudo,
544 U.S. 336 (2005) 17,29
In re Dura Pharms. Inc. Sec. Litig.,
No. 99CV0151, JLS (WMc),
2008 WL 483613 (S.D. Cal. Feb. 20, 2008). 10
Hawthorne v. Mac Adjustment, Inc.,
140 F.3d 1367 (11th Cir. 1998) 9
JHW Greentree Capital, L.P. v. Whittier Trust Co.,
No. 05 Civ. 2985 (HB),
2005 WL 3008452 (S.D.N.Y. Nov. 10, 2005) 27
Katz v. Image Innovations Holdings, Inc.,
No. 06 Civ. 3707 (JGK), 2008 WL 762105 (S.D.N.Y. Mar. 24, 2008) 10
Lentell v. Merrill Lynch & Co.,
396 F.3d 161 (2d Cir.), cert. denied, 546 U.S. 935 (2005) 27
Case 2:03-cv-01500-K0B-TMP Document 1391 Filed 05/27/2008 Page 6 of 41
Page(s)
In re Marsh & McLennan Cos. Sec. Litig.,
501 F. Supp. 2d 452 (S.D.N.Y. 2006) 27
Matsushita Elec. Indus. Co. v. Epstein,
516 U.S. 367 (1996) 20
In re National Century Fin. Enters., Inc., Inv. Litig.,
No. 2:03-md-1565, 2006 WL 469468 (S.D. Ohio Feb. 27, 2006) 27
In re National Century Fin. Enters., Inc., Inv. Litig.,
No. 2:03-md-1565, 2008 WL 918708 (S.D. Ohio Apr. 2, 2008) 13
In re Parmalat Sec. Litig.,
376 F. Supp. 2d 472 (S.D.N.Y. 2005) 27
Presnell v. Zant,
959 F.2d 1524 (11th Cir. 1992) 22
Provident Mut Life Ins. Co. of Philadelphia v. City of Atlanta,
864 F. Supp. 1274 (N.D. Ga. 1994) 9
Pugh v. Tribune Co.,
No. 06-3898, 2008 WL 867739 (7th Cir. Apr. 2, 2008) 10, 13, 14
In re Recoton Corp. Sec. Litig.,
358F. Supp. 2d1130 (M.D. Fla. 2005) 27
Regents of the University of California v. Merrill Lynch, Pierce,
Fenner & Smith, Inc.,
128 S. Ct. 1120 (2008) 21
Regents of the University of California v. Credit Suisse
First Boston (USA), Inc.,
482 F.3d 372 (5th Cir. 2007) passim
Robbins v. Koger Props., Inc.,
116 F.3d 1441 (11th Cir. 1997) 17,29
Rowinski v. Salomon Smith Barney Inc.,
398 F.3d 294 (3d Cir. 2005) 20
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Page (s)
SEC v. Zandford,
535 U.S. 813 (2002) 19
Simpson v. AOL Time Warner Inc.,
452 F.3d 1040 (9th Cir. 2006) 4
Stoneridge Investment Partners, L r v. Scientific-Atlanta, Inc.,
128 S. Ct. 761 (2008) passim
TCS Capital Mgmt., LLC v. Apax Partners, L.P.,
No. 06-CV-13477(CM),
2008 WL 650385 (S.D.N.Y. Mar. 7, 2008) 18
United States v. Savin,
349 F.3d 27 (2d Cir. 2003) 21
Wells v. Meyer 's Bakery,
561 F.2d 1268 (8th Cir. 1977) 22
STATUTES, RULES AND REGULATIONS
17 C.F.R. § 240.10b-5 8
-v-
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PRELIMINARY STATEMENT
In these cases, Stockholder and Bondholder Plaintiffs have asserted
two theories of liability against UBS 1 under Section 10(b) of the Securities
Exchange Act of 1934 (the "Exchange Act"): (1) their so-called "scheme to
defraud" theory under Rule 10b-5(a) and (c); and (2) their more traditional
"misrepresentation" theory under Rule 10b-5(b).
Under their "scheme" theory, Plaintiffs seek to hold DES liable for all
of their losses from HealthSouth's massive, multi-year accounting and financial
reporting fraud, even though there is no dispute that: (a) HealthSouth employees
carried out this fraud by making billions of dollars worth of false entries in
HealthSouth's accounting systems and financial records, (b) the vehicle for
deceiving investors was HealthSouth's publicly issued, fraudulent financial
statements; and (c) DES had no role at all in preparing HealthSouth's accounting
records or financial statements.
The time has come for this Court finally to put to rest Plaintiffs'
legally flawed "scheme" claims against DES. As the Supreme Court has now
made clear in its highly anticipated decision in Stoneridge Investment Partners,
LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761 (2008), Plaintiffs' "scheme" claims
against DES fail as a matter of law. As numerous courts, including the Seventh
The DES Defendants are DES AG, DES Securities LLC, Benjamin D.
Lorello, William C. McGahan and Howard Capek. For ease of reference, "DES"
is used here to refer to all or some of the DES Defendants.
Case 2:03-cv-01500-K0B-TMP Document 1391 Filed 05/27/2008 Page 9 of 41
Circuit, have confirmed, Stoneridge put to rest any notion of so-called "scheme"
liability. Plaintiffs' "scheme" claims have exaggerated the stakes and
unnecessarily complicated discovery and pretrial proceedings in this already
complex litigation. Dismissing Plaintiffs' legally deficient "scheme" claims now
will substantially narrow and simplify the issues in this case, including those that
bear upon the pending motion for class certification, and streamline expert
discovery, other pretrial proceedings and summary judgment motions.
Even before Stoneridge, this Court had expressed grave reservations
about the viability of Plaintiffs' "scheme" claims against DES. In its September 6,
2007 Opinion ("September 6 Opinion"), this Court observed that the Fifth Circuit's
rejection of indistinguishable "scheme" claims against the Enron investment banks
in Regents of the University of California v. Credit Suisse First Boston (USA), Inc.,
482 F.3d 372 (5th Cir. 2007), "casts serious doubt" on Plaintiffs' "scheme claims"
against DES here. (September 6 Opinion at 5, 10.) Yet, because the then-pending
Stoneridge petition "present[ed] the same question as Regents," this Court
concluded that "prudence require[d] awaiting further developments [from the
Supreme Court] before altering its prior ruling." (Id. at 5, 10.)
The "scheme" claims failed in Stoneridge, as they must in this case,
because this theory cannot satisfy the reliance element of Section 10(b). The
Supreme Court held that reliance upon each defendant's supposed deception is
essential to any claim under Section 10(b) because "[t]he conduct of a secondary
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actor must satisfr each of the elements or preconditions for liability." Stoneridge,
128 S. Ct. at 769 (emphasis added). Yet, as the Supreme Court held, the reliance
requirement cannot be met with respect to a third party that engaged in even
"[u]nconventional" transactions with an issuer when it was the issuer that later
misreported or otherwise misrepresented the transactions. Id. at 774. The
Stoneridge decision expressly rejected the notion — upon which all of Plaintiffs'
"scheme" claims against DES here rest — "that in an efficient market investors rely
not only upon the public statements relating to a security but also upon the
transactions those statements reflect." Id. at 770.
The Supreme Court also emphasized that a Section 10(b) claim based
on a third party's supposed participation in a public company's "scheme to
defraud" its investors raised a claim only for aiding and abetting barred by its
earlier decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver,
N.A., 511 U.S. 164 (1994). Stoneridge, 128 S. Ct. at 771. As the Court made
clear, imposing Section 10(b) liability on the theory that a third party, such as an
investment bank, violates Section 10(b) by allegedly committing a "deceptive act
in the process of facilitating the fraud" of a public company would impermissibly
"revive in substance the implied cause of action against all aiders and abettors."
Id. at 771. Here, as well, Plaintiffs' "scheme" claims against the DES Defendants
allege nothing more than aiding and abetting theories barred by Central Bank.
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Moreover, once Plaintiffs' legally flawed "scheme" claims are
dismissed, other fatal legal defects in Plaintiffs' remaining Section 10(b) claims
become readily apparent. Under settled law, these claims — alleging that DES
made some misrepresentations in research reports or offering documents — fail as a
matter of law to plead any viable theory of reliance or loss causation.
BACKGROUND
A. Plaintiffs' Flawed "Scheme" Theory of Section 10(b) Liability
In their Complaint, Plaintiffs rely on the theory that DES participated
in "a scheme that deceived the investing public regarding HealthSouth's true
financial condition." (Joint Third Amended Consolidated Complaint, dated April
30, 2007 (hereinafter "Complaint") 432.) In pressing their theory, Plaintiffs
parrot the same "principal purpose and effect" formulation — now expressly
rejected by the Supreme Court — from the Ninth Circuit's "Homestore" decision,
Simpson v. AOL Time Warner Inc., 452 F.3d 1040 (9th Cir. 2006), vacated and
remanded, 128 S. Ct. 1119 (2008): "The principal purpose and effect of the UBS
Defendants' activities was to create the false appearance of HealthSouth's financial
vitality and deceive HealthSouth's investors into believing that the Company was a
growing, thriving business." (Complaint 432.)
Plaintiffs do not allege that DES prepared or participated in preparing
any HealthSouth financial statements. Indeed, unlike the allegations in Regents
and Stoneridge, the accounting misstatements here are not even premised on the
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misrecording of transactions involving DES, but the outright fabrication by
HealthSouth insiders of HealthSouth's revenues and other accounting entries.
Plaintiffs allege merely that DES participated in HealthSouth's "scheme" by
providing various forms of financial advice and services to HealthSouth, including:
(i) advisory services on time-barred transactions that occurred years
before the start of the Class Period (and which, for the most part, did
not involve DES) (see Complaint 433(a), 434-42) and two
unconsummated transactions (id. 443);
(ii) DES's participation, along with dozens of other banks, in
HealthSouth credit facilities (id. 433(e), 459-62);
(iii) sewing as an initial purchaser, with other banks, in Rule
144A/Exxon Capital debt transactions (id. 433(b), 444-450);
(iv) engaging in financing transactions with several HealthSouth
affiliates (id. 433(f), 463-465); and
(vi) advising on (mostly time-barred) stock repurchases undertaken by
HealthSouth (id. 32, 433(d); see September 6 Opinion at 7-8).
B. The Misrepresentation Claims
In addition to their "scheme" claims, Plaintiffs separately allege
misrepresentation claims contending that DES is liable under Section 10(b) for
supposed misrepresentations in (i) four Confidential Private Placement
Memoranda issued in connection with HealthSouth's Rule 144A debt transactions,
and (ii) various HealthSouth equity research reports authored by DES analyst
Howard Capek. (See Complaint, Appendix 6.) These claims rest entirely — and
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impermissibly — on the legally deficient scheme claims to establish reliance and
loss causation. (Stockholder Plaintiffs' Opposition to the DES Defendants'
Motion to Dismiss Plaintiffs' Amended "Scheme" and Securities Act Theories, at
57 (Sept. 12, 2006) (hereinafter "Stockholders' 2006 Opp'n").)
C. Regents
As this Court held in its September 6 Opinion, the Fifth Circuit's
holding in Regents, if applied here, would require dismissal of Plaintiffs' "scheme"
claims against DES. The defendants in Enron were alleged to have a far broader
participation in "a far-reaching fraudulent scheme designed to take liabilities off
Enron's books temporarily to create the appearance that Enron was generating
revenue when it was actually incurring debt," all of which the Fifth Circuit held
insufficient as a matter of law to state a claim. (September 6 Opinion at 8 (citing
Regents, 482 F.3d at 377).) As this Court observed, the Regents court found that
"the investment banks' allegedly deceptive conduct 'at most aided and abetted
Enron's deceit by making its misrepresentations more plausible. The banks'
participation in the transactions, regardless of the purpose or effect of those
transactions, did not give rise to primary liability under §10(b)." (Id. at 9
(quoting Regents, 482 F.3d at 390) (emphasis added).)
D. The Supreme Court's Stoneridge Decision
Stoneridge was a putative class action on behalf of shareholders of
Charter Communications, Inc. ("Charter"), a cable television provider, against,
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among others, Respondents Scientific-Atlanta, Inc. and Motorola, Inc.
("Respondents"), two suppliers of cable set top boxes to Charter. Stoneridge, 128
S. Ct. at 766. Respondents allegedly engaged in a variety of transactions designed
for the express purpose of inflating Charter's revenues, including (i) producing
fictional revenues by overpaying for cable boxes in one year with the agreement
that the overpayment would be repaid later through the "purchase" of worthless
advertising, (ii) preparing false documents to make the deals appear substantive,
and (iii) back-dating agreements to create the appearance that these arrangements
were unrelated, which was necessary to dupe Charter's accountants. Id. at 766-67.
The Stoneridge plaintiffs alleged that Respondents violated Section
10(b) by arranging these round-trip sham transactions that "had no economic
substance," but instead had "the purpose and effect of creating a false appearance
of material fact to further a scheme to misrepresent Charter's revenue." Id. at 766,
770. The Supreme Court accepted as true plaintiffs' assertion that Respondents
knew that Charter "inten[ded] to use the transactions to inflate its revenues and
knew the resulting financial statements issued by Charter would be relied upon by
research analysts and investors." Id. at 767. According to Plaintiffs, Charter's
false financial statements were "a natural and expected consequence of
respondents' deceptive acts," establishing a sufficient "causal link to apply
Basic's presumption of reliance to respondents' acts." Id. at 770 (citing Basic Inc.
v. Levinson, 485 U.S. 224 (1988)).
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The Supreme Court disagreed, holding that the attenuated notions of
reliance and loss causation underlying plaintiff's "scheme liability" theory could
not state a viable claim under Section 10(b). Id. at 770. At the outset, the Court
bluntly rejected any notion that so-called "scheme" liability might exist simply
because such a claim invoked words contained in SEC Rule 10b-5, 17 C.F.R.
§ 240.10b-5. "Rule 10b-5 encompasses only conduct already prohibited by §
10(b)." Id. at 768. Thus, the scope of liability is governed solely by the words of
the statute, and the "narrow dimensions" of the judicially created private right of
action under Section 10(b). Id. at 774.
The Supreme Court rejected Plaintiffs' "scheme" theory for at least
three reasons. First, the "scheme" theory could not provide the requisite reliance to
establish liability under Section 10(b), because the theory did not purport to
establish direct reliance on any action of the scheme participants, which runs afoul
of the rule that the "conduct of a secondary actor must satisfy each of the elements
or preconditions for liability." Id. at 769. Second, the theory would "revive in
substance the implied cause of action against aiders and abettors" that was
previously rejected in Central Bank. Id. at 771. Third, as a judicially created right
of action that Congress has declined to expand in the Private Securities Litigation
Reform Act ("PSLRA"), "the § 10(b) private right should not be extended beyond
its present boundaries" by judicial fiat. Id. at 773.
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Shortly after Stoneridge, the Supreme Court denied the certiorari
petition filed by plaintiffs in the Regents case.
STANDARD ON THIS MOTION
"Judgment on the pleadings is appropriate when there are no material
facts in dispute, and judgment may be rendered by considering the substance of the
pleadings and any judicially noticed facts." Hawthorne v. Mac Adjustment, Inc.,
140 F.3d 1367, 1370 (11th Cir. 1998). "A motion for judgment on the pleadings is
subject to the same standard as is a Rule 12(b)(6) motion to dismiss." Provident
Mitt Life Ins. Co. of Philadelphia v. City of Atlanta, 864 F. Supp. 1274, 1278
(N.D. Ga. 1994). To state a claim, the allegations must "plausibly suggest' and
not be "merely consistent with' a violation of the law. Davis v. Coca-Cola
Bottling Co. Consol., 516 F.3d 955, 974 n.43 (11th Cir. 2008) (quoting Bell Atl.
Corp. v. Twombly, 127 S. Ct. 1955, 1966 (2007)).
ARGUMENT
I. UNDER STONERIDGE AND REGENTS, JUDGMENT MUST BE
ENTERED FOR UBS ON PLAINTIFFS' "SCHEME" CLAIMS.
A. Stoneridge Rejected, as a Matter of Law, Plaintiffs' "Scheme"
Theory Here.
I. Following Stoneridge, There is No "Scheme" Liability.
Plaintiffs' "scheme" claims against DES cannot possibly state a
Section 10(b) claim here, because the Supreme Court in Stoneridge flatly rejected
the viability of any so-called "scheme to defraud" liability theory. Stoneridge, 128
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S. Ct. at 770-773. Indeed, applying Stoneridge, lower courts have consistently
held that "Plaintiffs' allegations of scheme liability fail on the basis of Supreme
Court precedent." In re Dura Pharms. Inc. Sec. Litig., No. 99CV0151, JLS (WMc),
2008 WL 483613, at *11 (S.D. Cal. Feb. 20, 2008). "[A]fter Stoneridge, a theory
of scheme liability cannot be coupled with the efficient market theory to provide
grounds for asserting claims against secondary actors whose alleged deceptive
conduct was not relied upon by investors." TCS Capital Mgmt., LLC v. Apax
Partners, L.P., No. 06-CV-13447(CM), 2008 WL 650385, at *25 (S.D.N.Y. Mar.
7, 2008). In short, after Stoneridge, the "scheme" theory of liability is dead letter.
Pugh v. Tribune Co., 521 F.3d 686, 696 (7th Cir. 2008) ("allegations of so-called
'scheme liability' are insufficient under the Supreme Court's recent decision in
Stoneridge"); Katz v. Image Innovations Holdings, Inc., No. 06Civ.3707(JGK),
2008 WL 762105, at *2 (S.D.N.Y. Mar. 24, 2008) (claim that defendants 'are
liable as participants in a fraudulent scheme' to defraud purchasers of Image stock"
fails under Stoneridge) (citations and internal quotations omitted).
Thus, labeling some act or event a "scheme to defraud" has no
relevance under the securities laws. While the Supreme Court recognized that
"conduct" might establish one of the elements of a Section 10(b) claim — the
existence of a materially misleading act or omission — that "conduct" must be
"communicated to the public" to be actionable. Stoneridge, 128 S. Ct. at 769. In
other words, after Stoneridge, the only relevant question is whether each
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defendant's conduct separately "satisflies] each of the elements or preconditions
for liability" Stoneridge, 128 S. Ct. at 769; accord Central Bank, 511 U.S. at 191.
Here, none of Plaintiffs' scheme claims do so.
In their recent submissions, Plaintiffs wrongly claimed that Stoneridge
"does not rule out liability" for "transactions structured and designed solely to
impact the price of the issuer's securities" or to "allow a company to fraudulently
make its quarterly and year-end numbers." (Stockholder Plaintiffs' Response to
DES's Submission of Recent Legal Authority Relevant to this Court's September
6, 2007 Opinion at 2, 6 (filed Jan. 23, 2008) (hereinafter "Stockholders' Stoneridge
Brief').) But those are precisely the sort of allegations that the Supreme Court
held deficient in Stoneridge: allegations that sham transactions were developed
and papered with false, back-dated documents to transform what was, in essence, a
year-end loan into revenues and to allow Charter to prepare financials "showing it
met projected revenue and operating cash flow numbers." 128 S. Ct. at 766-67. In
other words, the Supreme Court in Stoneridge rejected far stronger allegations than
what Plaintiffs say survived.
2. Plaintiffs Cannot Establish Reliance on Any UBS Conduct
"Reliance by the plaintiff upon the defendant's deceptive acts is an
essential element of the § 10(b) private cause of action. It ensures that, for liability
to arise, the 'requisite causal connection between a defendant's misrepresentation
and a plaintiffs injury' exists as a predicate for liability." Stoneridge, 128 S. Ct. at
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769 (quoting Basic, 485 U.S. at 243). The Supreme Court confirmed that the
reliance that must be proven under Section 10(b) is not merely reliance upon some
"scheme" or part of it, but Plaintiffs must allege and prove direct reliance on
DES's "own deceptive conduct." Stoneridge, 128 S. Ct. at 770 (emphasis added).
Thus, it is not enough that UBS supposedly knew that HealthSouth intended "to
use the transactions to inflate its revenues," or that "the resulting financial
statements issued by" HealthSouth in fact were relied upon by investors. Id. at
767.
In Stoneridge, the Supreme Court rejected the notion that reliance
could be established because the fraud required the third party's complicity, and
the issuer's false financial statements were "a natural and expected consequence of
respondents' deceptive acts." Id. at 770. In doing so, the Court made clear that
"there is no authority for th[e] rule" — urged by Plaintiffs here — "that in an
efficient market investors rely not only upon the public statements relating to a
security but also upon the transactions those statements reflect." Id.
Following Stoneridge, investors must show direct reliance on each
defendant's own supposed deceptive act, because Section 10(b) "does not reach all
commercial transactions that are fraudulent and affect the price of a security in
some attenuated way." Id. at 771. As the Seventh Circuit held:
[The defendant] may have foreseen (or even intended) that the . . .
scheme would result in improper revenue . . . , which would
eventually be reflected in [the issuer's] revenues and finally published
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in its financial statements. But Stoneridge indicates that an indirect
chain to the contents of false public statements is too remote to
establish primary liability.
Pugh, 521 F.3d at 697; see also In re National Century Fin. Enters., Inc. Fin. Invs.
Litig., No. 2:03-md-1565, 2008 WL 918708, at *6-*7 (S.D. Ohio Apr. 2, 2008) (no
Section 10(b) liability for engaging in "legitimate transactions" where "Plaintiffs
allege that they were deceived concerning the [transactions] . . . from the way
another defendant described them").
Here, as in Stoneridge, the "deceptive acts" supposedly engaged in by
DES "were not disclosed to the investing public [and are thus] too remote to
satisfy the requirement of reliance." Stoneridge, 128 S. Ct. at 770. As Stoneridge
held, "Lilt was Charter, not [its service providers], that misled its auditor and filed
fraudulent financial statements [and] nothing [the service providers] did made it
necessary or inevitable for Charter to record the transactions as it did." Id. at 770.
"[T]he implied right of action does not reach" third parties that engage in
transactions that "allowed the investors' company to mislead its auditor and issue a
misleading financial statement affecting the stock price . . . because the investors
did not rely upon their statements or representations." Id. at 766.
Therefore, it is no answer to claim, as Stockholders attempt to do, that
"DES designed and then executed transactions so that they would have to be
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accounted for in a way that disguised HealthSouth's true financial situation."2
(Stockholders' Stoneridge Brief at 10.) The same argument was presented — and
rejected — in Stoneridge, even though the defendants in Stoneridge, unlike here,
actually prepared the false documentation and false back-dated contracts that
enabled Charter to falsify its financials and to justify the false financials to its
auditor. Id. at 767; see Pugh, 521 F.3d at 696-97 (Stoneridge forecloses claim
against the "mastermind" of a "scheme" that was "intended" to "result in improper
revenue").
3. Plaintiffs' "Scheme" Claims Allege Only Legally Non-
Existent Aider and Abettor Liability.
In Stoneridge, the Supreme Court also rejected the "scheme" theory
under Section 10(b), because a claim alleging that a third party committed
deceptive acts in furtherance of an issuer's fraud would allow a claim for aiding
and abetting in violation of Central Bank. The Court ruled that plaintiffs may not
end-run the ban on aider and abettor liability by alleging that the secondary actor
"committed a deceptive act in the process of providing assistance." Id. The Court
2
Of course, this contrived argument (nowhere presented in the Complaint) is
demonstrably false. The transactions at issue did not "have to be accounted for" in
any particular way or in any way that misrepresented HealthSouth's financials.
HealthSouth later restated its financial statements, which Plaintiffs presumably
agree accurately reflect HealthSouth's financial condition since they cite those
restated financials at length to justify their attempt to claim that HealthSouth
committed some multi-billion dollar fraud. Moreover, the "fraud" that is the focus
of this case has nothing at all to do with HealthSouth's accounting for any services
or transactions involving UBS, but rather a claim that HealthSouth simply recorded
fictional assets and revenues in its core business for over a decade or more.
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found that this construction of Section 10(b) "would revive in substance the
implied cause of action against all aiders and abettors except those who committed
no deceptive act in the process of facilitating the fraud; and we would undermine
Congress's determination that this class of defendants should be pursued by the
SEC and not by private litigants." Id.
Here, too, Plaintiffs allege nothing more than aider and abettor claims
barred by Central Bank. Like the sham transactions supported by false
documentation allegedly designed to deceive Charter's auditors and investors at
issue in Stoneridge, the DES conduct Plaintiffs allege was designed to facilitate the
HealthSouth fraud or to deceive investors or "credit agencies" (Stockholders'
Stoneridge Brief at 6-8), at most aided and abetted HealthSouth's fraud, which
relates to the misrecording of assets, liabilities and revenues, whatever the
supposed bona fides of the underlying transactions with HealthSouth. TCS
Capital, 2008 WL 650385, at *25 (after Stoneridge, "even if this conduct did help
the Buyers to carry out their scheme . . . plaintiff has no claim under the federal
securities laws").
4. Plaintiffs' "Scheme" Claims Against UBS Lack Any Viable
Theory of Loss Causation.
The Stoneridge Court rejected scheme liability, because this theory
failed, as it must, to satisfy each element of a Section 10(b) claim for each
defendant, but instead sought to impute the issuer's misstatements to the third party
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for purposes of establishing reliance and loss causation. 128 S. Ct. at 769-71.
Under Section 10(b), however, Plaintiffs must prove a violation with respect to
each defendant's "own deceptive conduct." Id. at 770. Here, even if some
"scheme" theory remained viable — and it does not — Plaintiffs have never even
offered any theory of loss causation confined to some deceptive conduct by any
DES Defendant.
Instead, Plaintiffs have alleged merely that the HealthSouth fraud
itself — rather than any actionable DES conduct — caused their losses.
(Stockholders' 2006 Opp'n at 57). Yet, under Stoneridge, Plaintiffs may not rely
on HealthSouth's accounting fraud to establish loss causation as to any claims
against a DES Defendant. 128 S. Ct. at 770. Loss causation may not be shown by
reference to losses caused by other individuals or events. Cordova v. Lehman
Bros., 526 F. Supp. 2d 1305, 1320 (S.D. Fla. 2007) (dismissing complaint because
"the direct cause of the decline in value of the investments was the
misappropriation of investor funds by PFA and its insiders, not any
misrepresentation or omission of Defendants"); see also In re Coca-Cola Enters.
Inc. Sec. Litig., No. 1:06-CV-0275-TWT, 2007 WL 2904160, at *3 (N.D. Ga. Oct.
3, 2007) (rejecting loss causation allegations because price declined in response to
events not at issue in the case).
More recently, Plaintiffs seem to have reversed field and argued that
various financings or other services provided by DES inflated HealthSouth's
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securities prices and led to Plaintiffs' losses. (Stockholders' Stoneridge Brief, at
10-12). However, a "showing of price inflation . . . does not satisfy the loss
causation requirement." Robbins v. Koger Props., Inc., 116 F.3d 1441, 1448 (11th
Cir. 1997); Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 346 (2005).
Plaintiffs offer no argument or allegation that the decline in
HealthSouth's securities prices — i.e., the loss for which causation must be proven
— was in any direct, proximate way related to some UBS deception. The Eleventh
Circuit "explicitly require[s] proof of a causal connection between the
misrepresentation and the investment's subsequent decline in value." Robbins, 116
F.3d at 1448.
5. Stoneridge Rejected "Scheme" Liability Based on the Narrow
Scope of the Section 10(b) Private Right of Action, Not the
Particular Services Provided by a Defendant.
Recognizing that Stoneridge completely rejects their scheme theory,
Plaintiffs attempt to confine the decision to certain commercial transactions, but
not to those in the "investment sphere." (Stockholders' Stoneridge Brief at 2-12;
Bondholder Plaintiffs' Response to DES Defendants' Submission of Recent Legal
Authority Relevant to this Court's September 6 Opinion at 3-4 (filed Jan. 22, 2008)
(hereinafter "Bondholders' Stoneridge Brief'). The Supreme Court plainly did not
limit its holding to a narrow group of defendants, illogically suggest that a federal
statute should be interpreted differently for different defendants or different
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segments of the economy, or allow plaintiffs to revive deficient claims simply by
alleging that they arose in the "investment sphere."
First, the services provided by a defendant, or whatever label
Plaintiffs may wish to attach to them, cannot alter the fundamental defects in
Plaintiffs' theory, namely, the inability to establish reliance and loss causation
separately for each challenged act or omission by each defendant. Whether the
challenged transactions took place in the "investment sphere" or in the
"atmosphere" is immaterial because Stoneridge holds that Plaintiffs may not claim
to have relied upon the underlying transactions or services that were misreported or
unreported by HealthSouth, or to have been injured by some supposed DES act or
omission that was never revealed to investors. TSC Capital, 2008 WL 650385, at
*25 (Stoneridge bars claim against a party to a merger agreement).
Second, when setting forth the "conflict" among Circuit courts to be
resolved by the Stoneridge decision, the Supreme Court — citing only Regents (a
case against investment banks) and Homestore (a case against commercial
vendors) — indicated that its decision resolved the question of "when, if ever, an
injured investor may rely upon § 10(b) to recover from a party that neither makes a
public misstatement nor violates a duty to disclose but does participate in a scheme
to violate § 10(b)." Stoneridge, 128 S. Ct. at 767-68. In answering that question,
the Supreme Court held that a third party cannot be liable for an issuer's false
statements or inaccurate financials by virtue of having participated in "not so
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ordinary course" or "[u]nconventional" transactions designed to enable the issuer
to engage in the misrepresentation. Id. at 774. The Court did not distinguish
among the nature of the actors, or suggest that the "conflict" between Regents and
Hornestore was illusory because of the type of the transactions at issue. To the
contrary, the round-trip transactions found inactionable in Stoneridge were, in
essence, disguised loans, which, by Plaintiffs' own reasoning, fall squarely within
the "investment sphere." (Stockholders' Stoneridge Brief at 7-11). And, the
Supreme Court confirmed that no "investment sphere" exception exists by denying
certiorari in Regents notwithstanding identical arguments by those plaintiffs.
Third, the Court's holding was squarely premised on the narrow
private right of action available under Section 10(b), and not the identity of the
parties. The private right of action under Section 10(b) is not a statutory right, but
a judicially created right of action. 3 "Concerns with the judicial creation of a
private cause of action caution against expansion. . . . Though it remains the law,
the § 10(b) private right should not be extended beyond its present boundaries."
Stoneridge, 128 S. Ct. at 773 (emphasis added). Thus, the Supreme Court's
rejection of "scheme" liability was premised on "the narrow dimensions we must
3
For this reason, the rationale of SEC v. Zandford, 535 U.S. 813, 820 (2002)
— which this Court relied on for its "endorsement of an expansive construction of
section 10(b)" (September 6 Opinion, at 7, 8) — does not apply here because
Zandford involved the SEC's broad statutory enforcement rights, and not the more
limited implied private right of action.
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give to a right of action Congress did not authorize when it first enacted the statute
and did not expand when it revisited the law." Id. at 774.
Fourth, Plaintiffs' assertion that the Stoneridge decision "focuses on
the critical difference between § 10(b) and Rule 10b-5(a) and (c) in the context of
fraud perpetrated by financial professionals like DES versus ordinary vendor-type
business transactions like those in Stoneridge" is mystifying. (Stockholders'
Stoneridge Brief at 2, 5.) The Court did not "focus" on any difference between
Rule 10b-5 and Section 10(b) or even discuss it, but declared any difference
between the Rule and the statute to be entirely irrelevant, because an administrative
rule cannot expand the scope of a statute. "Rule 10b-5 encompasses only conduct
already prohibited by § 10(b)." Stoneridge, 128 S. Ct. at 768; Central Bank, 511
U.S. at 173 ("the private plaintiff may not bring a 10b-5 suit against a defendant
for acts not prohibited by the text of § 10(b)").
Finally, Plaintiffs' illogical assertion that the elements of a cause of
action might differ under Section 10(b) depending upon the industry in which the
defendant operates or the nature of the transactions engaged in, would turn
centuries of jurisprudence on its head. E.g., Matsushita Elec. Indus. Co. v.
Epstein, 516 U.S. 367, 383 (1996) (Congress intended Exchange Act "to achieve
greater uniformity of construction and more effective and expert application of that
law"); Davies Warehouse Co. v. Bowles, 321 U.S. 144, 155 (1944) ("uniform
operation of a federal law is a desirable end"); Rowinski v. Salomon Smith Barney
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Case 2:03-cv-01500-K0B-TMP Document 1391 Filed 05/27/2008 Page 28 of 41
Inc., 398 F.3d 294, 302 (3d Cir. 2005) (recognizing Securities Litigation Uniform
Standards Act's "goal of facilitating the uniform application of 'national standards
for securities class action lawsuits involving nationally traded securities')
(quoting 15 U.S.C. § 78a), United States v. Savin, 349 F.3d 27, 35 (2d Cir. 2003)
(observing the general "preference for the uniform application of federal law").
B. The "Extremely Persuasive" Regents Decision Remains Good
Law, and Requires Judgment for UBS.
1. Regents Remains a Correct Statement of the Law.
The Supreme Court expressly framed the issue to be decided in
Stoneridge as resolving a "conflict" between the Fifth Circuit's Regents decision
and the Ninth Circuit's Homestore decision concerning the extent of liability for
those who "participate in a scheme." Stoneridge, 128 S. Ct. at 767-68. The
Supreme Court unequivocally resolved that conflict by denying certiorari in
Regents, Regents of the Univ. of CaL v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 128 S. Ct. 1120 (2008), while at the same time vacating and remanding the
Homestore decision "for further consideration in light of Stoneridge." Avis Budget
Group, Inc. v. Cat State Teachers' Ret Sys., 128 S. Ct. 1119 (2008). Hence,
following Stoneridge, the Regents decision remains good law, while the Ninth
Circuit's Homestore decision was rejected by the Supreme Court. 128 S. Ct. at
774-75 (Stevens, J., dissenting) (noting that the majority rejected Homestore).
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Plaintiffs contend that any inferences from the Supreme Court's
varying treatment of the cases before it amounts to nothing more than reading tea
leaves. (Bondholder Plaintiffs' Response to DES Defendants' Submission of
Further Recent Legal Authority at 2 (filed Jan. 25, 2008) (hereinafter
"Bondholders' Jan. 25 Response")) But it was the Supreme Court that read those
leaves, not DES. The Supreme Court singled out Regents and Homestore as
representing the conflict to be resolved by its decision, and the Court left Regents
intact, and vacated Homestore. While it is true, as Bondholders argue, that the
denial of certiorari in Regents does not amount to an affirmance on the merits, that
does not mean that the Supreme Court's disparate treatment of the conflicting
decisions before it should be overlooked. Wells v. Meyer's Bakery, 561 F.2d 1268,
1274-75 (8th Cir. 1977) ("Although the denial of a writ of certiorari by the
Supreme Court has no particular significance, the fact that certiorari was denied in
Stewart. . . only four weeks after Teamsters was decided, cannot be overlooked.").
Thus, the conflicting, simultaneous treatment given to cases raising the same issue
"does reflect the Supreme Court's assessment of a . . . court's efforts to comply
with the Supreme Court's instructions." Presnell v. Zant, 959 F.2d 1524, 1532
(11th Cir. 1992).
Plaintiffs' efforts to minimize the significance of the Supreme Court's
denial of certiorari in Regents are understandable, because Stockholders' counsel
argued to the Supreme Court, without success, that the Court should grant
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certiorari in Regents and either (i) rule that Stoneridge should be limited to its
facts, or (ii) vacate and remand the case for further consideration by the Fifth
Circuit. (See Supplemental Brief in Support of the Petition, Regents of the
University of California v. Merrill Lynch, Pierce, Fenner & Smith, Inc., No. 06-
1341, dated January 17, 2008, at 1-3, attached hereto as Exhibit 1.) All of the
arguments presented by Plaintiffs in their submissions to this Court regarding the
Stoneridge decision were made — often verbatim — to the Supreme Court in support
of the Regents plaintiffs' plea to grant certiorari or vacate Regents. (See Ex. 1, at
2-9). Among other things, the Regents plaintiffs — represented by Stockholders'
counsel — implored the Court to grant certiorari in that case and "clariftyf that
Stoneridge applies only to claims against "mere customers or suppliers," but not to
claims against "investment bankers, underwriters and securities analysts." (Id. at
1.)
The Supreme Court declined that invitation to fashion a special rule
for investment banks, and left the Regents decision intact.
2. Regents Cannot be Distinguished From the Facts Alleged
Here and Requires Judgment for UBS.
In support of their "scheme" theory, Plaintiffs urged this Court — for a
time, successfully — to follow Judge Harmon's decision sustaining the same theory
of "scheme" liability with respect to a few of the investment bank defendants
alleged to have facilitated the massive financial fraud at Enron. (September 6
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Opinion at 4-5)4 Of course, the Fifth Circuit reversed, holding — in what this
Court characterized as a "compelling" and "extremely persuasive" opinion (Sept. 6
Opinion at 5, 10) — that "[t]he transactions in which the banks engaged at most
aided and abetted Enron's deceit by making its misrepresentations more plausible."
Regents, 482 F.3d at 390. The Fifth Circuit did so despite the fact that all of these
defendant banks operated in the "investment sphere," and all allegedly were far
more involved with the Enron fraud than DES supposedly was involved with
HealthSouth here.
Indeed, despite Bondholders' disingenuous attempt to dismiss Regents
as involving "allegations of attenuated conduct unknown to the public" or
defendants that "owed no duty of disclosure to the class of investors in Enron and,
in fact, made no statements to them and directed no deceptive conduct towards
them" (Bondholders' January 25 Response, at 3), it is beyond dispute that all of the
assertions lodged against DES here — and far worse — were considered and rejected
in Regents, including assertions that the Enron investment banks:
• "were fiduciaries with a duty to make full disclosures" (Ex. 1, at 4);
• "were underwriters [and] made several knowingly false
representations to the market" (id.);
4
Judge Harmon, however, rejected the Enron plaintiffs' "scheme" claims
against all of the Enron investment banks whose conduct remotely approached the
insubstantial allegations against DES here. (See, e.g., DES's Motion to Dismiss
Plaintiffs' Amended "Scheme" and Securities Act Theories at 39-42 (filed Aug.
21, 2006) (outlining the more substantial allegations against Deutsche Bank and
Barclays).)
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• "drafted and disseminated offering materials hiding debt and reporting
phony revenues that they themselves had contrived for Enron to
report" (id.);
• "framed and disseminated [offering documents] into the market for
the specific purpose of inducing investors to purchase Enron
securities" (id.);
• "spoke to the market by structuring and supporting off-the-books
special purpose entities and related party transactions" (id. at 5);
• "executed transactions so that they would have to be accounted for in
a way that both hid Enron's debt and falsified its revenues" (id.
(emphasis in original));
• "deliberately us[ed] the sham transactions they created to mislead
investors and defraud the market" (id. at 7);
• issued analyst reports that "publicly represented Enron stock as a
'Strong Buy,' based on its phonied financials" when its "private belief
. . . was that Enron was an absolute 'don't buy' (id. at 7-8);
• "spoke[] through analyst reports, and indeed, . . . touted Enron's false
results, which their transactions created while recommending
purchase of Enron stock" (id. at 9).
Despite the Enron investment banks' supposed involvement in Rule
144A offerings, equity research, various financings, and much more, the Fifth
Circuit explicitly rejected the claim that the defendant banks were fiduciaries or
otherwise owed Enron investors any duty of disclosure: "Enron had a duty to its
shareholders, but the banks did not." Regents, 482 F.3d at 390 (emphasis added).
The Fifth Circuit likewise rejected plaintiffs' numerous allegations
contending that Enron's banks "target[ed]" their deceptive conduct at Enron's
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Case 2:03-cv-01500-K0B-TMP Document 1391 Filed 05/27/2008 Page 33 of 41
investors or otherwise devised fraudulent transactions for the express purpose of
enabling Enron to report false financials. "The transactions in which the banks
engaged at most aided and abetted Enron's deceit by making its misrepresentations
more plausible. The banks' participation in the transactions, regardless of the
purpose or effect of those transactions, did not give rise to primary liability under
§ 10(b)." Id. (footnote omitted, emphasis added).
Indeed, the only even arguably relevant distinction between Regents
and this case is that Regents held that far greater entanglements by Enron's
investment banks in Enron's business or financial transactions nevertheless could
not render the banks liable for the issuer's financial fraud. In contrast to the basic
DES banking and financing services challenged here, the Enron banks were
alleged to have engaged in a host of other acts in furtherance of the Enron fraud
that extend well beyond any of the allegations against UBS here.5
5
Among other things, those banks supposedly (i) "helped Enron structure and
finance several of the illicit SPEs and partnerships Enron controlled"; (ii)
"creat[ed] some of the illicit SPEs which were the primary vehicles by which
Enron falsified its financial condition and misrepresented profits"; (iii) "made
disguised loans to Enron so that Enron's true credit situation, liquidity and debt
levels could be disguised"; (iv) "entered into two sets of bogus transactions with
Enron" where "[n]either of the 'transactions' had any economic purpose
whatsoever, other than to increase Enron's stock price and generate present and
future fees" for the bank; and (v) engaged in fictional transactions and "created
bogus power swaps." (First Am Compl. 694, 706, 707, 735, 742.7, In re Enron
Corp. Sec. Derivative & ERISA Litig., No. H-01-3624 (S.D. Tex. filed May 14,
2003) (Relevant excerpts attached hereto as Ex. 2.).)
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II. ONCE PLAINTIFFS' "SCHEME" CLAIMS ARE ELIMINATED,
THEIR REMAINING SECTION 10(B) CLAIMS ALSO ARE
DEFICIENT.
Plaintiffs also allege liability against DES and/or Howard Capek
based upon supposed public misstatements in HealthSouth's private placement
memoranda and DES equity research reports. Yet, Plaintiffs have never offered
any theory or allegation of reliance or loss causation with respect to these claims.
It is settled that Plaintiffs' misrepresentation claims cannot provide
the requisite loss causation or reliance to support their scheme claims. 6 Nor may a
"scheme" claim be relied upon as "a back door into liability" for a false statement
or omission under Section 10(b). In re Parmalat Sec. Litig., 376 F. Supp. 2d 472,
503 (S.D.N.Y. 2005). Hence, as with any other claim under Section 10(b),
Plaintiffs must establish each element of the statute with respect to their claim that
DES or Capek made some misstatement in violation of Section 10(b). Stoneridge,
128 S. Ct. at 769; Central Bank, 511 U.S. at 180.
6 See Lentellv. . Merrill Lynch & Co. Inc., 396 F.3d 161, 177 (2d Cir.)
("[P]laintiffs [cannot] cast. . . claims in terms of market manipulation, pursuant to
Rule 10b-5(a) and (c)[,] . . . where the sole basis for such claims is alleged
misrepresentations or omissions."), cert. denied, 546 U.S. 935 (2005); In re
Marsh & McLennan Cos. Sec. Litig., 501 F. Supp. 2d 452, 490-91 (S.D.N.Y. 2006)
(same); In re National Century Fin. Enters., Inc., Inv. Litig., No. 2:03-md-1565,
2006 WL 469468, at *21 (S.D. Ohio Feb. 27, 2006) (rejecting scheme claims that
"merely repeated the allegations made in support of [their] misrepresentation and
omission claim under Rule 10b-5(b)" (citing Lentell, 396 F.3d at 177)); JHW
Greentree Capital, L.P. v. Whittier Trust Co., No. 05 Civ. 2985 (HB), 2005 WL
3008452, at *7 n.11 (S.D.N.Y. Nov. 10, 2005) (same); In re Recoton Corp. Sec.
Litig., 358 F. Supp. 2d 1130, 1138 n.4 (M.D. Fla. 2005) (same).
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Here, however, Plaintiffs always have rested their theories of reliance
and loss causation on HealthSouth's overall accounting fraud, rather than any
discrete DES statement. Plaintiffs have never explained, for example, how they or
any "market" relied upon any statement in the confidential private placement
memoranda (which, by definition, are not "public" statements) or any DES
research report (which contained no new information and were distributed to a
limited audience). Plaintiffs thus have not, and cannot, plead reliance here.
Similarly, Plaintiffs' sole allegations and arguments relating to loss
causation contend only that the HealthSouth fraud caused their losses.' Even then,
Plaintiffs allege only that the fraud (or DES's supposed participation in it) caused
Plaintiffs to pay too much for their HealthSouth securities:
Plaintiffs and the other members of the Stockholder Class and Merger
Subclasses, as detailed herein, have suffered damages in that, in
reliance on the integrity of the market, they paid artificially inflated
prices in connection with their acquisition of HealthSouth securities.
(Stockholder Plaintiffs' Legal Theories and Claims 66, filed Apr. 30, 2007).
7
Throughout this action, Plaintiffs have claimed that they had satisfied the
loss causation requirement of Section 10(b) by citing simply "the fraudulent
scheme which inflated HealthSouth's stock." (Stockholders' 2006 Opp'n at 57;
see also Stockholders' Response to the DES Defendants' Submission of Recent
Legal Authority in Further Support of Their Motion to Dismiss at 2, 6, dated
February 6, 2006 (Docket No. 445), (claiming Stockholders have sufficiently
alleged loss causation by "alleg[ing] that the DES Defendants participated in a
scheme to defraud" and "detail[ing] the acquisition and integrated debt offering
scheme"); (Bondholder Plaintiffs' Opposition to DES Motion to Dismiss at 198
(filed Nov. 4, 2004) ("[T]he scheme — of which Capek's direct participation was an
integral and necessary part — was so pervasive that, without it, HealthSouth could
not have issued the Notes.").)
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As a result of the dissemination of the materially false and misleading
information and failure to disclose material facts, as set forth above,
the market prices of the Unregistered Notes and the Registered Notes
were artificially inflated during the Bondholder Class Period. In
ignorance of the fact that the market prices of the Unregistered Notes
and the Registered Notes were artificially inflated . . . Bondholder
Plaintiffs and the other members of the Bondholder Class acquired the
Unregistered Notes and the Registered Notes during the Bondholder
Class Period at artificially high prices and were damaged thereby.
(Bondholder Plaintiffs' Legal Theories and Claims 423, filed Apr. 30, 2007).
It is by now settled that claims of "purchase price inflation" such as
Plaintiffs make here are insufficient to establish loss causation. Robbins, 116 F.3d
at 1448. In fact, Plaintiffs' conclusory loss causation allegations are
indistinguishable from those rejected by the Supreme Court in Dura. Dura, 544
U.S. at 340 (rejecting loss causation allegation that alleged "[i]n reliance on the
integrity of the market, [plaintiffs] . . . paid artificially inflated prices for Dura
securities' and the plaintiffs suffered `damage[sf thereby").
Stripped of their blunderbuss "scheme" theory, Plaintiffs have offered
no allegations or theory of reliance or loss causation in connection with their
misrepresentation claims. For this reason, judgment also should be entered for
DES on these claims.
CONCLUSION
For all the foregoing reasons, all of Plaintiffs' Section 10(b) claims
premised on their "scheme to defraud" theory fail as a matter of law. In addition,
the Court should revisit the viability of Plaintiffs' remaining claims in the absence
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Case 2:03-cv-01500-K0B-TMP Document 1391 Filed 05/27/2008 Page 37 of 41
of the now-defunct scheme claims. Under settled precedent, those claims also fail
to allege any facts or viable theory supporting reliance or causation.
Respectfully submitted,
Of Counsel: s/ W. Michael Atchison
W. Michael Atchison (ASB-4005-T75W)
Robert J. Giuffra, Jr. Jay M. Ezelle (AZB-4744-Z72J)
Brian T. Frawley Robin H. Jones (ASB-0769-R51J)
Julia M. Jordan STARNES & ATCHISON LLP
Erin R. Chlopak 100 Brookwood Place, Seventh Floor
SULLIVAN & CROMWELL LLP Birmingham, Alabama 35209
125 Broad Street (205) 868-6000
New York, New York 10004
(212) 558-4000 Counsel for UBS AG, UBS Securities LLC,
Howard Cape/c, Benjamin D. Lorello and
Counsel for UBS AG, UBS Securities William C. McGahan
LLC, Howard Cape/c, Benjamin D.
Lorello and William C. McGahan
Helen Gredd
Daniel Gitner
Thomas Fitzpatrick LANKLER SIFFERT & WOHL LLP
LAW OFFICES OF THOMAS 500 Fifth Avenue
FITZPATRICK New York, New York 10110
500 Fifth Avenue, 33rd Floor (212) 921-8399
New York, New York 10110
(212) 930-1290 Counsel for William C. McGahan
Counsel for Howard Capek
Robert J. Anello
Richard F. Albert
MORVILLO, ABRAMOWITZ, GRAND,
IASON, ANELLO & BOHRER, P.C.
656 Fifth Avenue
New York, New York 10017
(212) 856-6000
Counsel for Benjamin D. Lorello
May 27, 2008
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CERTIFICATE OF SERVICE
I hereby certify that on this the 27th day of May, 2008, I electronically filed the
foregoing with the Clerk of the Court using the CM/ECF system which will send
notification of such filing to the following:
Richard Martin Adams parkman@parkmanlawfirm.com
Richard F. Albert ralbert@maglaw.com
Kelso L. Anderson kanderson@labaton.com
Robert J. Anello ranello@maglaw.com
William P. Ashworth washworth@wc.com
W. Michael Atchison wma@stameslaw.com
Patrick J. Ballard pjballard@ballardlawoffice.com
Edward J. Bennett ebennett@wc.com
Max W. Berger mwb@blbglaw.com
Stanley D. Bernstein Bemstein@bemlieb.com
Jeffrey R. Blackwood jblackwood@bradleyarant.com
Carmine D. Boccuzzi cboccuzzi@cgsh.com
Bruce R. Braun bbraun@winston.com
Charles F. Brega cbrega@lindquist.com
Vincent Briganti vbriganti@ldbs.com
Scott S. Brown scottbrown@maynardcooper.com
Carl S. Burkhalter cburkhalter@maynardcooper.com
Hope T. Cannon hcannon@bradleyarant.com
James A. Caputo jimc@csgrr.com
Michael J. Chepiga mchepiga@stblaw.com
John P. Coffey sean@blbglaw.com
Betsy P. Collins betsy.collins@alston.com
Bryan E. Comer bec@cbcbb.com
J. Erik Connolly econnolly@winston.com
Julia Boaz Cooper jbcooper@bradleyarant.com
N. Lee Cooper lcooper@maynardcooper.com
Patrick C. Cooper darceneaux@maynardcooper.com
Patrick J. Coughlin patc@csgrr.com
John T. Crowder, Jr. jtc@cbcbb.com
Robert T. Cunningham, Jr. rtc@cbycb.com
Stephen D. Dargitz sdargitz@skadden.com
Charles A. Dauphin cdauphin@bddmc.com
Manuel J. Dominguez jdominguez@bermanesq.com
David R. Donaldson DavidD@dglawfirm.com
Richard T. Dorman rtd@cbcbb.com
Russell Jackson Drake ecf@whatleydrake.com
Wayne W. Drinkwater jaltobelli@bradleyarant.com
-31-
Case 2:03-cv-01500-KOB-TMP Document 1391 Filed 05/27/2008 Page 39 of 41
Thomas A. Dubbs tdubbs@labaton.com
Robert D. Eckinger roberteckinger@arlaw.com
Jay M. Ezelle JME@stameslaw.com
Steven M. Farina sfarina@wc.com
Joseph A. Fawal jfawal@bellsouth.net
H. L. Ferguson, Jr. hlf@ffdlaw.com
Thomas Fitzpatrick tfitzpatrick@tfitzpatrick.com
Robert Fleishman rfleishm@steptoe.com
Joseph A. Fonti jfonti@labaton.com
Brian Thomas Frawley frawleyb@sullcrom.com
Lauren C. Freundlich lfreundlich@lswlaw.com
Henry Frohsin hfrohsin@bakerdonelson.com
Stephen J. Fuzesi sfuzesi@wc.com
Galloway & Somerville, LLC jgs@gallowaysomerville.com
Daniel M. Gitner dgitner@lswlaw.com
Robert J. Giuffra giuffrar@sullcrom.com
Paul Gluckow pgluckow@stblaw.com
Beata Gocyk-Farber Beata@blbglaw.com
Jonah H. Goldstein jonahg@csgrr.com
James L. Goyer, III jgoyer@maynardcooper.com
David C. Gray dgray@wc.com
Helen A. Gredd hgredd@lswlaw.com
David J. Guin davidg@dglawfirm.com
Jeffrey M. Haber haber@bemlieb.com
Anthony C. Harlow ach@stameslaw.com
J. Mark Hart jmh@hsy.com
David R. Hassel DavidH@blbglaw.com
Frederick G. Helmsing fgh@helmsinglaw.com
James F. Henry jhenry@bradleyarant.com
James F. Hughey, III jhughey@lfwlaw.com
Susan E. Hurd shurd@alston.com
Harriet Thomas Ivy hivy@bakerdonelson.com
B. Keith Jackson kj@rileyjacksonlaw.com
James W. Johnson jjohnson@labaton.com
G. Douglas Jones ecf@whatleydrake.com
Robin H. Jones RHJ@stameslaw.com
Julia M. Jordan jordanjm@sullcrom.com
Sheilah M. Kane skane@cgsh.com
Francis P. Karam Karam@bemlieb.com
M. Kay Kelley kaykelley@mindspring.com
Allison R. Kimmel akimmel@stblaw.com
Renu Kara Kripalani rkripalani@labaton.com
Jennifer Y. Lai jlai@csgrr.com
Othni J. Lathram ecf@whatleydrake.com
-32-
Case 2:03-cv-01500-KOB-TMP Document 1391 Filed 05/27/2008 Page 40 of 41
Jeffrey N. Leibell jeffl@blbglaw.com
William S. Lerach BillL@Lerachlaw.com
Nathan R. Lindell nlindell@csgrr.com
Ryan A. Llorens ryanl@csgrr.com
Don B. Long, Jr. dbl@jbpp.com
Mitchell A. Lowenthal mlowenthal@cgsh.com
Kallie C. Lunsford kallie@rileyjacksonlaw.com
Enu Mainigi emainigi@wc.com
Craig A. Martin cmartin@labaton.com
Alan Daniel Mathis adm@jbpp.com
Erskine Ramsey Mathis erskinelaw@aol.com
Lauren A. McMillan laurenm@blbglaw.com
Debra M. Mestre Mestregfc@aol.com
Judith L. Mogul jmogul@maglaw.com
Benjamin M. Moncrief bmoncrief@bradleyarant.com
Kan M. Nawaday knawaday@lswlaw.com
James L. O'Kelley jimokelley@bellsouth.net
Stephen C. Olen sco@cbcbb.com
Keith F. Park keithp@csgrr.com
James W. Parkman parkman@parkmanlawfirm.com
Michael J. Pucillo mpucillo@bermanesg.com
Maxwell H. Pulliam MHPulliam@csattomeys.com
Teresa T. Pulliam ttpulliam@msn.com
Barry A. Ragsdale barryrags@aol.com
M. Clay Ragsdale, IV clay@ragsdalellc.com
C. Lee Reeves lreeves@sirote.com
John J. Rice jrice@csgrr.com
Robert R. Riley, Jr. rob@rileyjacksonlaw.com
Michael P. Roche mroche@winston.com
Daniel 0. Rodgers dor@ffdlaw.com
Michael H. Rogers mrogers@labaton.com
Victoria Radd Rollins vrollins@wc.com
Nancy I. Ruskin nruskin@cgsh.com
Ann N Sagerson asagerson@wc.com
Michael Sansbury msansbury@spotswoodllc.com
Robert S. Saunders rsaunder@skadden.com
Andrew M. Schatz firm@snlaw.net
Jeffrey T. Scott scottj@sullcrom.com
Anne Marie Seibel aseibel@bradleyarant.com
Neil L. Selinger nselinger@ldbs.com
Maryanne Sexton msexton@maglaw.com
Jackson R. Sharman, III jsharman@lfwlaw.com
Kenneth 0. Simon KOS@csattomeys.com
Henry E. Simpson henry.simpson@arlaw.com
-33-
Case 2:03-cv-01500-KOB-TMP Document 1391 Filed 05/27/2008 Page 41 of 41
J. Callen Sparrow jcsparrow@hgdlawfirm.com
Beth A. Stewart bstewart@wc.com
Tammy McClendon Stokes tstokes@dglawfirm.com
Stephen A. Strickland sstrickland@rjaffelaw.com
Lawrence A. Sucharow lsucharow@labaton.com
Michael T. Tomaino tomainom@sullcrom.com
William H. Wagener wagenerw@sullcrom.com
Dan K. Webb dwebb@winston.com
Edward P. Welch ewelch@skadden.com
Joe R. Whatley, Jr. jwhatley@whatleydrake.com
William Calvin White, II wwhite@parkmanlawfirm.com
Laurent S. Wiesel wiesell@sullcrom.com
Thomas P. Windom twindom@wc.com
Nicole E. Wrigley nwrigley@winston.com
Debra J. Wyman debraw@csgrr.com
Respectfully submitted,
s/ Robin H. Jones
Robin H. Jones (ASB-0769-R51J)
STARNES & ATCHISON LLP
100 Brookwood Place, Seventh Floor
Birmingham, Alabama 35209
Telephone: (205) 868-6000
Fax: (205) 868-6099
E-mail: rhj@stameslaw.com
-34-
Case 2:03-cv-01500-K013-TMP Document 1391-2 Filed 05/27/2008 Page 1 of 16 FILED
2008 May-27 PM 06:43
U.S. DISTRICT COURT
N.D. OF ALABAMA
EXHIBIT 1
Case 2:03-cv-01500-K013-TMP Document 1391-2 Filed 05/27/2008 Page 2 of 16
No. 06-1341
IN THE
supreme Court of the U uittb ibtatess
THE REGENTS OF THE UNIVERSITY OF CALIFORNIA,
Petitioner,
V.
MEFIRILL LYNCH PIERCE FENNER & SMITH, INC.,
MERRILL LYNCH & COMPANY, INC.; CREDIT SUISSE
FIRST BOSTON (USA), INC ; CREDIT SUISSE FIRST
BOSTON LLC; PERSHING LLC; BARCLAYS PLC;
BARCLAYS BANK PLC; BARCLAYS CAPITAL, INC.
Respondents.
On Petition for Writ of Certiorari to the
United States Court of Appeals
for the Fifth Circuit
SUPPLEMENTAL BRIEF IN SUPPORT
PATRICK J. COUGHLIN *
HET EN J HODGES
BYRON S. GEORGIOU
ERIC ALAN ISAACSON
SPENCER A. Holm-10Lz
JOSEPH D. DALEY
ANNE L. Box
COUGHLIN STOIA GELLER
RUDMAN & BOBBINS LLP
655 West Broadway, Suite 1900
San Diego, CA 92101
* Counsel of Record (619) 231-1058
Counsel for Petitioner
(
WiLSON-EPES PRINTING CO., INC. - (202) 789-0096 - WASHINGTON D C 20002
e so
Case 2:03-cv-01500-K013-TMP Document 1391-2 Filed 05/27/2008 Page 3 of 16
TABLE OF CONTENTS
Page
TABLE OF AUTHORITIES
SUPPLEMENTAL BRIEF IN SUPPORT 1
CONCLUSION 10
(i)
Case 2:03-cv-01500-K013-TMP Document 1391-2 Filed 05/27/2008 Page 4 of 16
TABLE OF AUTHORITIES
CASES Page
Dolphin & Bradbury, Inc. v. SEC,
No. 06-1319, 2008 U.S. App. LEXIS 492
(D.C. Cir. Jan. 11, 2008) 4
First Virginia Bankshares v. Benson, 559
F.2d 1307 (5th Cir. 1977) 10
In re Enron Corp. Sec. Litig., No. H-01-
3624, 2006 U.S. Dist. LEXIS 43146 (S.D.
Tex. June 5, 2006) 7
Regents of the Univ. of Cal. v. Credit
Suisse First Boston, 482 F.3d 372 (5th
Cir. 2007) 2
Stoneridge Investment Partners, LLC v
Scientific-Atlanta, Inc., No. 06-43 (U.S
Jan. 15, 2008) 1, 2, 3, 5
STATUTES, RULES AND REGULATIONS
15 U. S. C.
§77k 3
§78j(b) 1, 2, 3, 7
Federal Rules of Civil Procedure
Rule 23(f) 7
U.S. Supreme Court
Rule 15.8 • 1
17 C.F.R.
§240.10b-5 2
Case 2 . 03-cv-01500-K013-TMP Document 1391-2 Filed 05/27/2008 Page 5 of 16
SUPPLEMENTAL BRIEF IN SUPPORT
Pursuant to Rule 15.8 of this Court, Petitioner The
Regents of the University of California respectfully
submits this Supplemental Brief In Support of its
Petition for a Writ of Certiorari, and in opposition
to the Supplemental Brief In Opposition filed by
Respondents on January 16, 2008. As set forth
below, this Court's Stoneridge opinion rejected the
rationale of the Eighth Circuit that the Fifth Circuit
followed in this case. Differences between Ston-
eridge, which involved liability of mere customers or
suppliers, and this case, where financial professionals
deliberately misled investors, make this case an
appropriate one to grant certiorari and clarify the
scope of §10(b) liability where it matters most—in
relationship to deliberately misleading conduct of
investment bankers, undenvriters and securities
analysts who had a duty to speak truthfully.
1. Respondents say there is no reasonable
possibility that the Fifth Circuit might meaningfully
reconsider in light of this Court's decision of
Stoneridge Investment Partners, LLC v. Scientific-
Atlanta, Inc., No. 06-43 (U.S. Jan. 15, 2008), as "the
Fifth Circuit's decision in this case relied extensively
on the Eighth Circuit decision now affinued in
Stoneridge." Supplemental Brief In Opposition at 2.
Yet the Eighth Circuit opinion says that only
misstatements, omissions by one who has a duty to
disclose, and manipulative trading practices (where
"manipulative" is a word of art) may be deemed
deceptive under §10(b). See Stoneridge, No. 06-43,
slip op. at 7.
In Stoneridge, this Court noted: "If this conclusion
were read to suggest there must be a specific oral or
written statement before there could be liability
Case 2 . 03-cv-01500-K08-TMP Document 1391-2 Filed 05/27/2008 Page 6 of 16
2
under §10(b) or Rule 10b-5, it would be erroneous."
Id. That, however, is precisely how the Fifth Circuit
read the Eighth Circuit's opinion, expressly following
its erroneous logic "that '"deceptive" conduct involves
either a misstatement or a failure to disclose by one
who has a duty to disclose.'" See Petition Appendix
("Pet. App.") at 21a [Regents of the Univ. of Cal. v.
Credit Suisse First Boston, 482 F.3d 372, 388 (5th
Cir. 2007)]. Indeed, the Fifth Circuit ruled that the
district court erred because it applied §10(b) and
Rule 10b-5 as written, and "by ascribing, natural,
dictionary definitions to the words of the rule," rather
than the contrived definition offered by the Eighth
Circuit. Pet. App. at 20a [Regents, 482 F.3d at 3871.
At a minimum, the Fifth Circuit should be allowed to
reconsider its holding in light of Stoneridge.
2, Far from warranting a denial of certiorari, this
Court's decision in Stoneridge demonstrates critical
differences between Enron and Stoneridge differ-
ences that warrant a grant of certiorari to detei mine
§10(b)'s scope not in the context of ordinary business
transactions addressed by Stoneridge, but in the con-
text of fraud perpetrated by financial professionals
engaged in fraudulent dealings in our securities
markets. Stoneridge holds that the §10(b) right of
action does not reach ordinary customer/supplier
companies when their partners in ordinary business
relations subsequently account improperly for the
transactions entered between or among them. It does
not rule out liability for fraud by financial profes-
sionals that is directed at securities transactions,
i.e., transactions structured and designed to make
quarterly and year-end numbers. Cf. Stoneridge, No.
06-43, slip op. at 16 (contrasting investors' lack of
reliance on suspicious transactions "in the market-
Case 2:03-cv-01500-KOB-TM P Document 1391-2 Filed 05/27/2008 Page 7 of 16
3
place for goods and services" with transactions taking
place "in the investment sphere").
Even more to the point, Enron simply is not a case
in which Petitioner seeks to apply §10(b) "beyond
the securities markets—the realm of financing
business—to purchase and supply contracts—the
realm of ordinary business operations." Stoneridge,
No. 06-43, slip op. at 10. Enron is, at its core, a case
about financial fraud, executed by financial
professionals targeting investors; it is not about
"ordinary business operations," Id. Although §10(b)
"does not reach all commercial transactions that are
fraudulent and affect the price of a security in some
attenuated way," Stoneridge, No. 06-43, slip op. at
11, it certainly does reach fraud by financial
professionals, in securities transactions—including
registered offerings—and other statements addressed
to the financial markets. Stoneridge emphasizes:
All secondary actors, furthermore, are not
necessarily immune from private suit. The
securities statutes provide an express private
right of action against accountants and under-
writers in certain circumstances, see 15 U. S. C.
§77k, and the implied right of action in §10(b)
continues to cover secondary actors who commit
primary violations.
Id. at 15.
This coverage, of course, includes an underwriter
who knowingly underwrites a fraudulent offering and
deliberately disseminates fraudulent offering docu-
ments, selling securities to the public. "'By par-
ticipating in an offering, an underwriter makes an
implied recommendation about the securities [that
it] . . has a reasonable basis for belief in the
Case 2:03-cv-01500-K013-TMP Document 1391-2 Filed 05/27/2008 Page 8 of 16
4
truthfulness and completeness of the key represen-
tations made in any disclosure documents used in the
offerings." Dolphin & Bradbury, Inc. v. SEC, No. 06-
1319, 2008 U.S. App. LEX1S 492, at *13 (D.C. Cir.
Jan. 11, 2008) (emphasis in original). In Enron, the
banks who were underwriters made several know-
ingly false representations to the market.
Respondents were Enron's underwriters for
numerous securities offerings, selling securities with
offering circulars, prospectuses and registration
statements containing false financial information.'
They drafted and disseminated offering materials
hiding debt and reporting phony revenues that they
themselves had contrived for Enron to report.
Investors were entitled to rely on the truthfulness of
the offering documents that Respondents framed and
disseminated into the market for the specific purpose
of inducing investors to purchase Enron securities.
And the Respondents as underwriters were fidu-
ciaries, with a duty to make full disclosures-
' Merrill Lynch underwrote sales of Enron stock and notes in
1999. First Amended Consolidated Complaint ("FACC") 1738.
Barclays acted as a placement agent and/or reedier with respect
to the public offering in February 2001 of Enron's $1.9
billion zero coupon notes. FACC 1752. In addition, Barclays
sold Enron-related securities: Yosemite Securities Co. Ltd.
L200 000 000 8.75% Series 2000-A Linked Enron Obligations.
FACC 11753. During the Class Period, CSFB was an under-
writer for one Enron stock offering and two debt offerings. In
addition, CSFB sold Enron-related debt, Osprey and Marlin.
FACC 111696-699. The summary judgment briefing, the letter
prefixed documents, the five-digit exhibit numbers, deposition
transcripts, analyst reports, complaints and sworn statements
cited herein are part of the record Petitioner submitted in the
Fifth Circuit Court of Appeals case, Regents v. Credit Suisse
First Boston, No. 06-20856 (5th Cir.).
Case 2:03-cv-01500-KOB-TM P Document 1391-2 Filed 05/27/2008 Page 9 of 16
5
completely unlike the independent customers and
suppliers in Stone ridge.
This Court's Stoneridge opinion emphasizes:
"First, if there is an omission of a material fact by one
with a duty to disclose, the investor to whom the duty
was owed need not provide specific proof of reliance."
Stoneridge, No. 06-43, slip op. at 8. "Second, under
the fraud-on-the-market doctrine, reliance is pre-
sumed when the statements at issue become public,"
as did the offering documents for Enron's public
offerings of securities. Id. Thus, though Respon-
dents deny it, facts supporting both of the pre-
sumptions on which reliance may be based are
present in this case.
3. In addition to being underwriters, these banks
spoke to the market by structuring and supporting
off-the-books special-purpose entities and related-
party transactions like Osprey, LJM1 and L,JM2 that
hid debt and provided false positive cash flow from
operations.' As this Court emphasized in Stoneridge,
in that case "nothing respondents did made it
necessary or inevitable for Charter to record the
transactions as it did." Id. at 10. In this case, by
contrast, Enron's bankers designed and then
executed transactions so that they would have to be
accounted for in a way that both hid Enron's debt and
falsified its revenues.' For example, Merrill Lynch
2 As investors have noted: "'My whole emphasis was, if
Merrill Lynch is selling it, it has to be good because they're the
biggest brokerage firm in the world,' said Joe Marsh, a Merrill
Lynch client. Paula Dwyer, Laura Cohn, Emily Thornton &
Wendy Zellner, Merrill Lynch: See No Evil, Business Week,
Sept. 16, 2002, at 3-4.
As CSF13 noted in 2000: As you probably know, Osprey is a
vehicle enabling Enron to raise disguised debt which appears as
Case 2:03-cv-01500-K0B-TMP Document 1391-2 Filed 05/27/2008 Page 10 of 16
6
and Andrew Fastow ("Fastow") structured and
launched LJM2 for the express purpose of engaging
with Enron in earnings and balance-sheet manage-
ment transactions—i.e., transactions designed to
deceive investors. LJM2 was designed and operated
as a "conduit" through which Merrill Lynch and
others indirectly engaged in these deceptive trans-
actions.° Having conceptualized, designed and
structured LJM2 for the deceptive purpose, according
to Fastow, of "managing [Enron's] earnings," Mei ill
Lynch is liable as a primary violator. At a minimum,
this case should be remanded to explore whether
these transactions meet this Court's causation
standards as set forth in Stoneridge.
4. Finally, Respondents note somewhat defen-
sively that this case also involves false statements
equity on Enron's balance sheet. . . Osprey serves the added
purpose for Enron of being an off-balance sheet parking lot for
certain assets." Ex. 10264. As Merrill Lynch noted in 1999
("Nigerian Barge"): "Jeff McMahon, EVP and Treasurer of
Enron Corp. has asked ML to purchase $7MM of equity in a
special purpose vehicle that will allow Enron Corp. to book
$12MM of earnings. Enron must close this transaction by
12/31199. Enron is viewing this transaction as a bridge to
pei inanent equity and they have assured us that we will be
taken out of our investment within six months. The investment
would have a maximum 22.5% return." MLBE0111776.
10/24/06 Deposition Transcript of Andrew Eastow ("10/24/06
Fastow Depo. Tr.") at 417:6-11. This testimony is corroborated
by numerous other facts, including the contemporaneous
documents showing that Merrill Lynch "approved" the year-end
1999 transactions—before it became a limited partner—and
that it was given detailed information as to each transaction
before it was asked to fund it. Moreover, Merrill Lynch
understood the deceptive purpose of the transactions and—
without any legitimate business purpose of its own—went
forward anyway.
Case 2:03-cv-01500-K0B-TMP Document 1391-2 Filed 05/27/2008 Page 11 of 16
7
issued by securities analysts in their employ—
including "buy" recommendations on Enron stock.
They say that the district court "dismissed the §10(b)
claims that were premised on statements of research
analysts on the entirely independent ground that
petitioner had not alleged that the specific employees
associated with the analyst reports had acted with
scienter," (Supplemental Brief In Opposition at 4)
(emphasis in original), but that Petitioner did not
cross-appeal the dismissals—as if Petitioner could
cross-appeal from an interlocutory dismissal order
when the only basis for appellate review was under
Federal Rule of Civil Procedure 23(0. The district
court directed the parties, in any event, to raise the
issue again on summary judgment if they so chose:
"If there is a question, it should be raised by motion
for summary judgment." In re Enron Corp. Sec.
Litig., No. H-01-3624, 2006 U.S. Dist. LEXIS 43146,
at *391 (S.D. Tex. June 5, 2006). Petitioner
accordingly cited Merrill Lynch's analyst reports in
its opposition to Merrill Lynch's currently pending
summary judgment motion and cited Credit Suisse
First Boston's ("CSFB") analyst reports in its op-
position to CSFB's pending summary judgment
motion. See Opposition to Merrill Lynch Motion for
Summary Judgment at 132 n.519; Opposition to
CSFB's Motion for Summary Judgment at 214-232.
The Petition for Certiorari, moreover, notes that
Merrill Lynch issued 15 analyst reports and CSFB
issued 19. Petition at 29 n.30.
The analysts' venality shows Respondents' du-
plicity in deliberately using the sham transactions
they created to mislead investors and defraud the
market. For example, CSFB publicly represented
Enron stock as a "Strong Buy," based on its phonied
financials, maintaining a target price of over $100
Case 2:03-cv-01500-K0B-TMP Document 1391-2 Filed 05/27/2008 Page 12 of 16
8
per share until July 2001, when it eventually lowered
the target to $84.' Its private belief, however, was
that Enron was an absolute "don't buy."'
In an October 2001 email from CSFB analyst
Brian Gibbons ("Gibbons") to analyst Andy DeVries
("DeVries"), Gibbons derided the illicit Enron
partnerships as "basic money laundering operations
in essence." Ex. 15637. Immediately thereafter, with
Enron shares trading at $35, Curt Launer and
DeVries issued an October 2001 analyst report rating
Enron a "Strong Buy" and issued a target price of
$54• 7 DeVries acknowledges that while he told his
friends not to pay even $35 a share for Enron, he told
CSFB's clients it was a great buy. See n.6.
Merrill Lynch did the same. According to Fastow,
he "drew a short straw" among Enron's senior
management in that he was asked to deliver the
message to Merrill Lynch as to its then-current
analyst John Olson ("Olson"), "that it would be
difficult, if not impossible, for Enron to give Merrill
the business of leading an equity offering for Enron
because their equity analyst was saying not to buy
the stock."' After Merrill Lynch fired Olson, it
appointed another equity analyst, Donato Eassey
Compare CSF8LLC006888291, CS113LLC006888293 with
CSFBLLC006888606, CSFBLLC006888608.
5/25/05 Deposition Transcript of Andy DeVries at 311:23-
312:19; accord Ers 15643 (DeVries email stating "I wouldn't
touch" Enron shares); Ex. 15647 (email communications evi-
dencing DeVries' personal "sell" recommendation to friends
saved them money).
CSFBI A C006844639, CSFBLLC006844641.
10/24/06 Fastow Depo. Tr. at 519:4-19
Case 2:03-cv-01500-K0B-TMP Document 1391-2 Filed 05/27/2008 Page 13 of 16
9
("Eassey"), to cover Enron 9 In Eassey's first report
on Enron, he upgraded Merrill Lynch's rating on
Enron stock from neutral to accumulate.'" Merrill
Lynch's reports contributed to statistically significant
stock price increases on January 19, 1999, April 13,
1999, November 9, 1999, January 20, 2000, January
21, 2000, January 24, 2000, April 12-13, 2000, July
27, 2000, January 22-23, 2001, April 18, 2001, May
18, 2001, June 27, 2001, and October 10, 2001. All
the while, Merrill Lynch was creating false revenues
for Enron to report through LJM2.
Having spoken through analyst reports, and indeed,
having touted Enron's false results, which their trans-
actions created while recommending purchase of
Enron stock (clearly satisfying the "in connection with"
requirement) unlike the defendants in Stoneridge,
the banks in this case had a duty to disclose what
each knew about those false results. This alone
raises a presumption of reliance based on "an omis-
9 5/21/03 Sworn Statement of Donato J. Eassey, former Vice
President in Securities and Research at Merrill Lynch, to Robb
Hellwid, A & B) at 14-15,
11) ELIB00000631-00001-04 (1120/99 Donato J. Eassey, Merrill
Lynch Comment: "Enron Corp.—Solid Results in a difficult
Environment"); 5/21/03 Sworn Statement of Donato J. Eassey at
27-28. See also Neal Batson Third Interim Report, Appendix I
at 22; 1119/99 Merrill Lynch Analyst Report at 1 ("Intermediate
Term: Accumulate") ("Enron Corp.—Solid Results In a Difficult
Environment"); 10/12/99 Merrill Lynch Analyst Report at 1
("Intermediate Term. Accumulate"); 1/20/00 Merrill Lynch
Analyst Report at 1 ("Intermediate Term. Accumulate"); 1/22/01
Men-ill Lynch Analyst Report at 1 ("Intermediate Term: Buy")
("Enron Corp.—Strength In Numbers and Then Some"); 4/18/01
Merrill Lynch Analyst Report at 1 ("Raising the Bar—Again")
("Vie reiterate our Buy opinions.").
Case 2:03-cv-01500-K0B-TMP Document 1391-2 Filed 05/27/2008 Page 14 of 16
10
sion of material fact by one with a duty to disclose."
Stoneridge, No. 06-43, slip op. at 8."
CONCLUSION
The fact is that Respondents are financial profes-
sionals who structured financial transactions that
deceived the market and were reported as structured.
In addition, Respondents did speak to the markets in
underwritings and analyst reports and as a result
had a duty to speak the full truth. This Court should
remove any doubt about what Stoneridge means by
granting certiorari to clarify when financial profes-
sionals may be liable for deliberately misleading
investors. At a minimum, the case should be
remanded for a fuller examination of the facts.
Respectfully submitted,
PATRICK J. COUGHLIN *
HELEN J. HODGES
BYRON S. GEORGIOU
ERIC ALAN ISAACSON
SPENCER A. BURKHOLZ
JOSEPH D. DALEY
ANNE L. Box
COUGHLIN STOIA GELLER
RUDMAN & ROBBINS LLP
655 West Broadway, Suite 1900
San Diego, CA 92101
* Counsel of Record (619) 231-1058
Counsel for Petitioner
January 17, 2008
""Silence, or omission to state a fact, is proscribed only in
certain situations: first, where the defendant has a duty to
speak, secondly, where the defendant has revealed some rele-
vant, material information even though he had no duty (i.e., a
defendant may not deal in half-truths)." First Virginia Bankshares
v. Benson, 559 F,2d 1307, 1314 (5th Cir. 1977).
Case 2:03-cv-01500-K0B-TMP Document 1391-2 Filed 05/27/2008 Page 15 of 16
CERTIFICATE OF SERVICE
No. 06-1341
THE REGENTS OF THE UNIVERSITY OF CALIFORNIA.,
Petitioner,
vs.
MERRILL LYNCH PIERCE FENNER & SMITH, INC., MERRILL LYNCH & COMPANY,
INC., CREDIT SUISSE FIRST BOSTON (USA), INC., CREDIT SUISSE FIRST BOSTON
LLC, PERSHING LLC, BARCLAYS PLC, BARCLAYS BANK PLC, BARCLAYS CAPITAL,
INC.
Respondents.
I, ERIC ALAN ISAACSON, a member of the Bar of this Court, hereby certify that on
January 17, 2008, I caused Wilson-Epes Printing Co., Inc. to serve three copies of the
Supplemental Brief In Support by first-class mail, postage prepaid, on the following persons:
Richard W. Clary E. Lawrence Vincent
CRAVATH, SWAINE & MOORE, LLP 3020 Legacy Drive, #100-324
Worldwide Plaza, Plano, TX 75023
825 Eighth Avenue (214) 680-1668
New York, NY 10019-7475 Attorneys for Archdiocese of Milwaukee
(212) 474-1000 Supporting Fund, Inc.
Attorneys for Credit Suisse First Boston
(USA), Inc., Credit Suisse First Boston
LLC, Pershing LLC
Stuart J. Baskin Michael J. Del Giudice
Stephen J. Marten CICCARELLO DEL GIUDICE &
SHEARMAN & STERLING LLP LAFON
599 Lexington Avenue 1219 Virginia Street, East, Suite 100
New York, NY 10022 Charleston, WV 25301
(212) 848-4000 (304) 343-4440
Attorneys for Merrill Lynch Pierce Attorneys for Employer-Teamsters Local
Fenner & Smith, Inc., Merrill Lynch & Nos. 175 & 505 Pension Trust Fund
Company, Inc.
Case 2:03-cv-01500-K0B-TMP Document 1391-2 Filed 05/27/2008 Page 16 of 16
,
,
'
,
David H. Braff Robert C. Finkel I
SULLIVAN & CROMWELL LLP WOLF POPPER LLP
125 Broad Street 845 Third Avenue
New York, NY 10004-2498 New York, NY 10022
(212) 558-4000 (212) 759-4600
Attorneys for Barclays PLC, Barclays Attorneys for Nathaniel Pulsifer
Bank PLC, Barclays Capital, Inc.
Sherrie R. Savett
BERGER & MONTAGUE, P.C.
1622 Locust Street
Philadelphia, PA 19103
(800) 424-6690
Attorneys for Slam Asset Management .
I also certify that I caused a copy of the above-referenced documents also to be served
electronically on January 17, 2008, on all counsel of record for the Respondents who have consented .,
to electronic service, and all other counsel of record for interested parties in the underlying ,
proceeding via the www.ESL3624.com website. This manner of electronic service is pursuant to the
United States District Court's Order in Newby v. Enron Corp., No. H-01-3624 (S.D. Tex.)
I further certify that all parties required to be served have been served.
COUGHLIN STOIA GELL 7
RUDMAN & ROBB As
le /
E--e,-1,t , n V,
ERIC ALAN —AACSON
655 West Broadway, Suite 1900
San Diego, California 92101
619/231-1058
Conte of Record for Petitioner
S:ICasesSlaranrontSupreme CournPOS for Response Supplemeal.doc
Case 2:03-cv-01500-K013-TMP Document 1391-3 Filed 05/27/2008 Page 1 of 12 FILED
2008 May-27 PM 06:44
U.S. DISTRICT COURT
N.D. OF ALABAMA
EXHIBIT 2
Case 2:03-cv-01500-K08-TMP Document 1391 -3 F iled 05/27/2008 Page 2 of 12
har Oita
•
MAY 1 4 7003 n
iidestmaiaut
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF TEXAS
HOUSTON DIVISION
In re ENRON CORPORATION SECURITIES § Civil Action No. H-01-3624
LITIGATION § (Consolidated)
This Document Rotates To:
CLASS ACTION
MARK NEWBY, et aL, Individually and On §
Behalf of All °there Similarly Situated,
§ FIRST AMENDED CONSOLMATED
Plaintiffs, § COMPLAINT FOR VIOLATION OF THE
§ SECURITIES LAWS
VS. •§
ENRON CORP., et al.,
• •
Defendants. I
THE REGENTS OF THE UNIVERSITY OF §
CALIFORNIA, et al., Inditridually and On .1
Behalf of All Others Similarly Situated,
••
Plaintiffs,
vs.
• f
KENNETH I.. LAY, JEFFREY K, sauna, I
ANDREW S. vAsrow, RICHARD A. §
CAUSEY, MARK A. FREVERT, STANLEY C. §
HORTON, KENNETH D. RICE, RICHARD B. §
BUY, LOU L. PAI, JOSEPH 144. PERKO,
(Caption continued an following page.)
Thb mitingipubliontlem is creative *tic fWly protactedby all applicable copyright len a nil as by acimpprupriatinn,
tads seam, unfair :competition end Wier applicable bin. The authors of this work hare added ithm co the underlying rowel
irazeisio herein dam* ate or more of the fallowing unique acid original aelacrion, ecordhatiom napiessloo. arthipmoent end
clamdflonlon of the Information.
No =might ia claimed lathe tem of ragulatiom, nod thy memo firm enalyrts' report' quoted within die watt
CoPriert 2002 by Wilhism B. Loath andhillbag Weill rientiedHynes &Lomb IL?. William & Laub ardLiilberg
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anyone ate. memial othadoed hada "thous the permithan of Wilt S. Lark end Milborg We* BOXIbbi Hymn & lab
LLP la prohibited.
Case 2:03-cv-01500-K0B-TMP Document 1391-3 Filed 05/27/2008 Page 3 of 12
KEN L. HARRISON, STEVEN J. ICEAN, §
REBECCA P. MARK-JUSBASCHE, JEFFREY §
MCMAHON, CINDY K. OLSON, JOSEPH W. §
SUTTON, MARK E. KOENIG, KEVIN P. §
HANNON, LAWRENCE GREG WHALLEY, §
ROBERT A. BELFER, NORMAN P. BLAKE, §
JR., RONNIE C. CHAN, JOHN H. DUNCAN, §
WENDY L. GRAMM, ROBERT K. JAEDICKE, §
CHARLES A. LEMAISTRE, JOE H. FOY, §
JOHN MENDELSOHN, PAULO V. FERRAZ §
PEREIRA, JEROME J. MEYER, JOHN A. §
URQUHART, JOHN WAICEHAM, CHARLS E. §
WALKER, HERBERT S. WINOKUR, JR., §
FRANK SAVAGE, ALLIANCE CAPITAL §
MANAGEMENT L.P., JOSEPH F.§
BERARDINO, THOMAS H. BAUER, DAVID B. §
DUNCAN, DEBRA A. CASH, DAVID §
STEPHEN GODDARD, JR., GARY B. §
GOOLSBY, MICHAEL M. LOWTHER, §
MICHAEL C ODOM, JOHN E. STEWART, §
MICHAEL L. BENNETT, BENJAMIN S. §
NEUHAUSEN, RICHARD R. PETERSEN, §
WILLIAM E. SWANSON, MICHAEL D. §
JONES, ARTHUR ANDERSEN LLP, §
ANDERSEN WORLDWIDE, S.C., ANDERSEN §
CO. (INDIA), ARTHUR ANDERSEN-PUERTO §
RICO, ANDERSEN LLP (CAYMAN ISLANDS), §
ARTHUR ANDERSEN-BRAZIL, ARTHUR §
ANDERSEN (UNITED KINGDOM), VINSON & §
ELICINS, L.L.P., J.P. MORGAN CHASE & CO., §
JP MORGAN CHASE BANK, JP MORGAN §
SECURITIES INC., CITIGROUP, INC., §
CITIBANK, N.A., SALOMON SMITH §
BARNEY, INC., SALOMON BROTHERS §
EN FERNATIONALLIMI FED, CREDIT SUISSE §
FIRST BOSTON (USA), INC., PERSHING LLC, §
CREDIT SUISSE FIRST BOSTON CORP., §
CANADIAN IMPERIAL BANK OF §
COMMERCE, CIBC WORLD MARKETS §
CORP., CIBC WORLD MARKETS PLC, CIBC §
[Caption continued on following page.]
Case 2:03-cv-01500-K08-TMP Document 1391-3 Filed 05/27/2008 Page 4 of 12
OPPENHEIMER CORP., BANK OF §
AMERICA CORP., BANC OF AMERICA §
SECURITIES LLC, MERRILL LYNCH & §
CO., INC., MERRILL LYNCH, PIERCE, §
FENNER & SMITH, INC., BARCLAYS PLC, §
BARCLAYS BANK PLC, BARCLAYS §
CAPITAL, INC., DEUTSCHE BANK AG, §
DEUTSCHE BANK SECURITIES INC., DB §
ALEX. BROWN LLC, DEUTSCHE BANK §
TRUST COMPANY AMERICAS, LEHMAN §
BROTHERS HOLDING, INC. and LEHMAN §
BROTHERS INC.,
Defendants. § DEMAND FOR JURY TRIAL
Case 2:03-0/-01 500-K08-TMP Document 1391-3 Filed 05/27/2008 Page 5 of 12
CS First Boston, Merrill Lynch, JP Morgan and CitiGroup participated in setting up or were early
investors in LIM2. Merrill Lynch and JP Morgan were the main lenders to LJM2 entities.
461. LIM2 solicited prospective investors as limited partners using a confidential Private
Placement Memorandum ("PPM") detailing, among other things, the "unusually attractive
investment opportunity" resulting from the partnership's connection to Enron. The favorable terms
of the early LJM2 investors were an opportunity for some of Enron's bankers to be regarded with
extremely high risk fee returns. Thus, JP Morgan, Merrill Lynch, CIBC and CitiGroup were early
investors in LJM2. The PPM emphasized Fastow's position as Enron's CFO, and that LJM2's day-to-
day activities would be managed by Fastow, Kopper and Glisan. It explained that "Wile Partnership
expects that Enron will be the Partnership's primary source of investment opportunities" and that it
"expects to benefit from having the opportunity to invest in Enron-generated investment
opportunities that would not be available otherwise to outside investors." The PPM specifically
noted that Fastow's "access to Enron's information pertaining to potential investments will contribute
to superior returns." Merrill Lynch was the Placement Agent of the PPM and Kirkland & Ellis was
legal counsel to LJ1vI2.
462. The transactions between Enron and LIM2 that most misstated Enron's financial
statements involved four SPEs known as the "Raptors." Similar to the Rhythms transaction, Enron
improperly used the value of its own equity to counteract declines in the value of certain of its
merchant investments, violating a basic accounting principle. See APB No, 9128. Enron used the
Raptors to avoid reflecting losses in the value of some of its investments on the Company's income
statement. If the value of the investments declined, the Raptors were designed so that the value of
the corresponding hedge would increase by an equal amount. Consequently, the decline— which was
recorded each quarter on Enron's income statement — would be offset by an increase in income from
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Case 2:03-cv-01500-K08-TMP Document 1391-3 Filed 05/27/2008 Page 6 of 12
[T]he now-infamous LJM2 partnership set up by Enron's former chief financial
officer, Andrew Fastow. It's been well-documented now ... that high-powered
finance firms such as CS First Boston, Merrill Lynch, JP Morgan and Citigroup, were
lured into the LJM2 partnership by the promise of potentially rich returns and the
chance to get an inside peek into Enron's mysterious deals.
* • *
... Wall Street — which got rich touting Enron — is still acting as if it has nothing
to answer for in the Enron mess.
So far, most Wall Street institutions have said little about the Enron debacle, issuing
either blanket "no comments," or denying any responsibility for the company's
collapse. CS First Boston, which underwrote more than $4.5 billion in Enron stock
and bond offerings — roughly 20% of Enron's total underwriting work since 1990 ...
has refused to say anything whatsoever. Men-ill Lynch, which lined up investors for
Fastow's LJM2 partnership and underwrote more than $4 billion in stock and bond
offerings for Enron, has been a bit more talkative — but only to say it's utterly
blameless.
* *
Between them, Citigroup and J.P. Morgan served as lead manager on more than $20
billion in syndicated bank loans to Enron over the past decade, with Citigroup also
underwriting more than $4 billion in stock and bond offerings for the company ....
... Wall Street has plenty of explaining to do. Jonathan Kord Lagemann, a securities
Lawyer and former general counsel for a brokerage firm, says the Enron affair exposes
the "enormous conflict of interest" inherent in these firms' efforts to be three things
at one time: underwriter, corporate analyst and stock seller. To start, there's the
obvious issue of whether pressure from their firms caused 10 of the 14 research
analysts who followed Enron to keep recommending the stock to investors, even as
the company was racing toward bankruptcy. A related issue is whether the analysts
knew or should've known just how dire the situation was at Enron, since many of
them work for firms that were invested in the partnerships that played a critical role
in Eaton's off-balance-sheet transactions.
646. One of the primary vehicles utilized by defendants to falsify Enron's financial
condition and results during the Class Period was a partnership called LIM2, which was secretly
controlled by Enron and was used to help create numerous SPEs (including the infamous Raptors)
with which Enron engaged in illusory transactions to artificially inflate Enron's profits while
1
concealing billions of dollars in debt that should have been on Enron's balance sheet, 14,11\ 112 was a
- 443 -
Case 2:03-cv-01500-K08-TMP Document 1391-3 Filed 05/27/2008 Page 7 of 12
privately held entity created by Enron with the help of Merrill Lynch, Andersen and Vinson & Elkins
at year-end 99. They knew, because LJM2 was going to be principally utilized to engage in
transactions with Enron where Enron insiders (Fastow, Kopper and Glisan) would be on both sides
of the transactions, that the LJM2 partnership would be extremely lucrative — virtually guaranteed
to provide huge returns to LIM2's partners. In fact, Fastow's dual role by which he could self-deal
on behalf of the partnership with Enron's assets was so important that investors in LJM2 were
assured that they did not have to make any additional capital contributions if Fastow's dual role
ended. As a result, Enron and Merrill Lynch decided that in raising the money to fund LIM2, they
would allow certain favored investment banks and/or high-level officers of those investment banks
to invest in LJM2 because they knew the investment was virtually guaranteed to produce
extremely good returns. In fact, the offering memorandum for the LJ1v12 partnership by which
Merrill secured investors into the partnership — which was not a public document — contained a
virtual invitation to benefit from the insider self-dealing transactions that LJM2 would engage in
It stressed the "unusually attractive investment opportunity" resulting from the partnership's
connection to Enron. It emphasized Fastow's position as Enron's CFO, and that LJM2's day-to-day
activities would be managed by Enron insiders Fastow, Kopper and Chum. It explained that "ill he
Partnership expects that Enron will be the Partnership's primary source of investment
opportunities" and that it "expects to benefit from having the opportunity to invest in Enron-
generated investment opportunities that would not be available otherwise to outside investors."
The Private Placement Memorandum ("PPM") specifically noted that Fastow's "access to Enron's
information pertaining to potential investments will contribute to superior returns." In addition,
investors were told that investors in a similar Fastow controlled partnership (JEW) that had done
deals with Enron like the ones LJM2 would do had tripled their investment in just two years! In
- 444 -
1
Case 2:03-cv-01 500-K013-TM P Document 1 391 -3 Filed 05/27/2008 Page 8 of 12
Barry S. Friedberg, $500,000
Chairman of global markets & investment banking
Richard Gordon, $500,000
Vice-Chairman, investment banking
(fired for refusing to cooperate with Senate investigation)
Daniel H. Bayly, $200,000
Head of Investment Banking
Robert J. McCann, $200,000
Head of Global Institutional Client Division
Thomas W. Davis, $150,000
President — Global Markets and Investment Banking
Brian Hehir, $150,000
Vice-Chairman, Investment Banking
Benjamin Sullivan, $150,000
Managing Director, Private Placements Group
(oversaw UM private placement)
742.7 But the creation of LJM2 alone could not adequately bolster Enron's 4thQ and year-
end 99 numbers, nor was it enough for Merrill Lynch to aid its relationship with Enron and rake in
investment banking fees. Consequently, Merrill Lynch entered two sets of bogus transactions with
Enron that falsely boosted Enron's 4thQ and year-end 99 profits approximately $72 million. In the
first transaction, Merrill Lynch "purchased" Nigerian barges from Enron in late 12199 to create fake
earnings for Enron of over $12 million, with a secret promise that Enron would buy the barges back
from Merrill Lynch six months later. In the second transaction, Merrill Lynch created bogus power
swaps on 12/31/99, to falsely inflate Enron's 4thQ and 99 profits $60 million. Neither of the
"transactions" had any economic purpose whatsoever, other than to increase Enron's stock price and
generate present and future fees for Merrill Lynch.
- 496-
Case 2:03-cv-01500-K08 -TM P Document 1391-3 Filed 05/27/2008 Page 9 of 12
illicit partnerships or SPEs, and helped Enron falsify its financial statements and misrepresent its
financial condition, while its securities analysts were issuing extremely positive — but false and
misleading — reports on Enron extolling its business success, the strength of its financial condition
and its prospects For strong revenue and earning growth in the future. In addition to the huge
underwriting, advisory and transactional fees, interest and commitment charges CitiGroup was
receiving from Enron and related entities, in return for CS First Boston's participation in the scheme,
CS First Boston executives were rewarded by being permitted to invest at least $223 million in the
lucrative LJM2 partnership.
694. CS First Boston's relationships with Enron were so extensive that top executives of
the firm constantly interacted with top executives of Enron, i.e., Lay, Skilling, Causey, McMahon
or Fastow, on almost a daily basis throughout the Class Period, discussing Enron's business, financial
condition, financial plans, financing needs, partnerships, SPEs and Enron's future prospects. CS
First Boston actively engaged and participated in the fraudulent scheme and furthered Enron's
fraudulent course of conduct in several ways. It participated in loans of over $4 billion to Enron
during the Class Period. It helped Enron raise over $3 billion from the investing public via the sale
of new securities during the Class Period. It helped Enron structure and finance several of the illicit
SPEs and partnerships Enron controlled, which were primary vehicles utilized by Enron to falsify
its reported financial results, and engaged in transactions with Enron to disguise loans to Enron and
help Enron falsify its reported financial condition, liquidity and creditworthiness.
695. In interacting with Enron, CS First Boston functioned as a consolidated and unified
entity. There was no so-called "Chinese Wall" to seal off the CS First Boston securities analysts
from the information which CS First Boston obtained in rendering commercial and investment
banking services to Enron. Alternatively, even if some restrictions were placed on the information
- 470 -
Case 2:03-cv-01500-K013-TMP Document 1391-3 Filed 05/27/2008 Page 10 of 12
705. In addition to its own direct liability for making false and misleading statements, CS
First Boston also participated in and furthered the fraudulent scheme by helping to finance or
otherwise participate in illicit transactions with Enron which it knew would contribute materially to
Enron's ability to continue to falsify its financial condition and thus continue the operation of the
Enron Ponzi scheme.
706. CS First Boston, like JP Morgan and CitiGroup, made disguised loans to Enron so
that Enron's true credit situation, liquidity and debt levels could be disguised. CS First Boston lent
Enron money using trades in derivatives. In 00, CS First Boston gave Enron $150 million to be
repaid over two years. Enron's payments would vary with the price of oil. Technically, the
transaction was a swap. But because CS First Boston paid Enron up front, the transaction was in fact
a loan — a reality admitted by CS First Boston. "It was like a floating-rate loan," said Pen
Pendleton, a CS First Boston spokesman. "We booked the transaction as a loan." Enron's
balance sheet misrepresented this transaction. Enron posted the banks' loans as "assets from price
risk management" and as "accounts receivable," admitted Charlie Leonard, a spokesman for
Andersen: The repayments that Enron owed the banks were listed as "liabilities from price risk
management" and possibly a small amount as accounts payable, Leonard said.
707. CS First Boston also knowingly engaged and participated in and, in furtherance of
the scheme, helped Enron by creating some of the illicit SPEs which were the primary vehicles by
which Enron falsified its financial condition and misrepresented profits. This was done by a group
of 10 bankers from CS First Boston who had joined CS First Boston from Donaldson Lufkin &
Jenrette in 98, led by Laurence Nath. Using the euphemism "structured products," Nath and his team
structured numerous illicit SPEs to engage in transactions with Enron to improperly boost Enron's
reported profits while moving billions of dollars of debt off Enron's balance sheet to the SPEs.
- 475 -
Case 2:03-cv-01500-K013-TMP Document 1391-3 Filed 05/27/2008 Page 11 of 12
These transactions included Marlin, Firefly, Mariner, Osprey, Whitewing, and the infamous Raptors.
With CS First Boston's help, Enron sold assets to these entities at inflated prices — prices that Enron
never could have obtained in arm's-length transactions with third parties, resulting in phony profits
while hiding billions of dollars of debt.
708. Nath and CS First Boston worked very closely with Vinson & Elkins and Andersen
to create and document these entities and these transactions. According to a former Enron employee,
"Monetise" was the buzzword. Everyone was always saying: "We have to monetise this." The
quick-fix solution was: "We'll sell it to LIM, or to Raptor, or to whatever the partnership of the
month was.... They'd pick up the phone and Larry Nash would come down to Houston for a week
or two and sit down with the ... accountants and come up with something." Nath would gather
with a group from Enron's treasury and global finance departments known inside the Company as
"Fastow's field marshals." This group included McMahon, Enron's former treasurer, and Glisan,
who took over from McMahon as treasurer.
709. Most of the vehicles that emerged from these meetings contained an unusual feature
created by Nath: they held Enron stock in order to comfort lenders and secure an investment grade
rating, but required Enron to inject more shares into the vehicles if the share price fell to certain
"trigger points" or prices i.e., $83-$19 per share They could also force their liquidation if Enron's
credit rating was downgraded and the debt of the SPEs became recourse to Enron in such
circumstances. "What I can't believe is that anyone ever got comfortable when you put all of this
stuff together. Taken in combination, these partnerships clearly posed a material risk for the
company," a knowledgeable banker has said. The trigger points inside the partnerships were a
time bomb. " There's no question that senior people at CFSB knew what was going on and that
it was a house of cards," one Enron insider has said. The triggers were discussed by senior
- 476-
Case 2:03-cv-01500-K0B-TMP Document 1391-3 Filed 05/27/2008 Page 12 of 12
733. CIBC knew that Enron was falsifying its publicly reported financial results and that
its true financial condition was much more precarious than was publicly known. It obtained this
knowledge due to its access to Enron's internal business and financial information as one of Eaton's
lead lending banks, as well as its intimate interaction with Enron's top officials which occurred
virtually on a daily basis.
734. Thus, C1BC is directly liable to the Class for making false and misleading statements
in Registration Statements and Prospectuses utilized by Enron and C1BC to raise billions of dollars
of new capital for Enron, for false and misleading statements in analysts' reports written and issued
by CIBC, which helped to artificially inflate the trading price of Ertron's publicly traded securities,
as well as for its knowing participation in a fraudulent scheme, course of conduct and fraudulent
course of business of Enron, which operated to defraud purchasers of Enron's publicly traded
securities during the Class Period.
F. Involvement of Merrill Lynch
735. Merrill Lynch is a huge financial services firm which had an extensive and extremely
close relationship with Enron. During the Class Period it provided investment banking services to
Enron, helped structure . and finance one or more of Enron's illicit partnerships or SPEs, while its
securities analysts were issuing extremely positive reports on Enron extolling its business success,
the strength o f its financial condition and its prospects for strong future earnings and revenue growth.
736. Merrill Lynch's relationships with Enron were so extensive that top executives of the
firm constantly interacted with top executives of Enron, i.e., Lay, Skilling, Causey, McMahon or
Fastow, on almost a daily basis throughout the Class Period, discussing Eruon's business, financial
condition, financial plans, financing needs, its partnerships and SPEs and Eaton's future prospects.
Schyler Tilney was the head of Merrill Lynch's Energy Investment banking operation. Schyler
- 489 -