The Enron Shareholders' Suit:
A Tale of Two Law Firms, One Dismissed and One Still A Defendant

In my last column on the shareholders' suit against Enron and other defendants, I described an important ruling by Judge Melinda Harmon. In her ruling, Judge Harmon expanded the scope of federal law on securities fraud, in order to keep secondary actors--such as the law firms and accountants that helped Enron--on the hook.

The Securities and Exchange Commission had argued, in effect, that a law or accounting firm can be found to have committed a "primary" direct harm if it can be shown that the it "made" the misrepresentation upon which the victim relied. Judge Harmon agreed.

Obviously, Judge Harmon's ruling on this point was helpful to the plaintiffs, in that she held that in principle, lawyers and accountants can be held liable to private parties for securities fraud. Nevertheless, her application of that principle in practice still did not give the plaintiffs everything they wanted.

The Difference In the Outcomes for Kirkland & Ellis and Vinson & Elkins

Judge Harmon looked at the facts the plaintiffs, and even assuming them to be true - as judges are required to do when resolving a motion to dismiss - she held that only V&E could be held liable to the shareholders. K&E, on the other hand, might have "breached professional ethical standards" but could not have breached the federal securities laws.

What was the difference between the two firms? It was not the firms' relative degrees of involvement with Enron. Rather, according to Judge Harmon, it was that the papers K&E prepared were for a group of private partnerships, whereas the work V&E did was for a public company.

K&E created the private partnerships (including the oddly named "Chewco"). Then, according to the plaintiffs' allegations, Enron, with the help of V&E, used the partnerships to make statements that deceived Enron shareholders. To put it more simply, K&E stayed in the back room, where Enron, with V&E's help, took the podium and spoke to the public.

Thus, K&E might, if the allegations were true, have aided and abetted wrongdoing. But it did not "make" a misrepresentation to shareholders, as Enron and V&E allegedly did.

Moreover, according to the Supreme Court's ruling in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., aiding and abetting - in the sense of providing substantial assistance to - someone whom one knows will engage in fraud through misrepresentation, is not covered by the securities laws. Only "making" that representation is.

Central Bank's Fine Distinction

Central Bank's distinction may, in many cases, be a fine one - perhaps too fine to work in practice.

Take this case, for instance: K&E allegedly helped Enron structure fraudulent partnerships. V&E allegedly aided Enron in communicating with the public about the partnership in a way that did not disclose the fraud. Is one really closer to the representations about the partnerships - which, after all, were made by Enron, and not either law firm - than the other?

The truth is that it is companies themselves that send out prospectuses or press releases, under their own name. No shareholder receives letters directly from the company's accountants or lawyers; they receive communications directly from the company itself. Indeed, as Judge Harmon's opinion admitted, shareholders may not even know the identity of the lawyers and accountants involved.

Judge Harmon must have considered this, of course. But she found a way a lawyer could be liable: by participating in the drafting of the company's statement. Co-drafting a statement, she reasoned, was part of the process of "making" it, and thus V&E, which allegedly co-drafted Enron's statements, along with Enron employees, could be liable.

Was Judge Harmon's Solution Correct? Co-Authors Versus Enablers

Judge Harmon's solution is attractive for two reasons. First, it seems to lead to the right result--secondary actors who were clearly in cahoots with Enron are possibly held liable for their acts.

Second, it seems to capture more realistically the messy world of corporate securities. It would be naive to think that only "Enron"--the corporation--was the author of the statements that were consumed by the analysts and business press, and that in turn went into the market's valuation of Enron's shares. No company in its right mind sends out a prospectus or press release without getting its counsel to do some legal vetting first. Indeed, one of the purposes of the securities laws is to inspire that kind of caution.

So it seems to make sense to keep V&E in, at least for the moment, to see if the plaintiffs can prove their allegations against the firm. But what about letting K&E out? That seems more questionable - though arguably, Judge Harmon had no choice about it, given the Supreme Court's Central Bank holding.

If the plaintiffs allegations are true, then the private partnerships created by Enron's officer were crucial to plaintiff's alleged "Ponzi scheme," as Judge Harmon described the claim. Without them, Enron would not have been able to inflate its own assets. Without them, it could not have constructed the fraudulent tales that were then broadcast to the market with the help of its lawyers and accountants.

If a co-author also "makes" a statement, then doesn't an enabler "make" it too? Under Judge Harmon's ruling, one clearly need not publish a statement to "make" it - Enron was the publisher. Nor need one be the statement's primary author. Then perhaps the test should be that one "makes" the statement - in the sense of participating in the process that leads to its making - if one contributes to its making in a crucial way, as K&E allegedly did with respect to Enron's statements about the partnerships.

Judge Harmon must have rejected this test because she believes that a co-author is more than an enabler - for a co-author is speaking to the shareholder in a way the enabler is not. Both V&E and K&E probably could have foreseen the kind of statements Enron would make about the partnerships. But only V&E actually helped word exactly what was said. In this sense, its participation in the alleged misrepresentations was more direct.

But does directness equal culpability? It might, but Judge Harmon was probably motivated not by a perception that V&E was the greater wrongdoer, but rather by a fear of a "floodgates" problem. If securities fraud liability extended to anyone who had anything to do with the company activities about which misrepresentations were made, then plaintiffs could sue a raft of defendants - even a greater raft than currently named in the Enron shareholders' suit.

Judge Harmon is to be praised for her honest attempt to make sense of the bounds of responsibility of professionals in cases of securities fraud - and to do so in a way that both reaches wrongdoing, insofar as is possible, and comports with Supreme Court precedent.

The real solution now may have to come from Congress - which could amend the securities laws to more easily reach wrongdoing lawyers and accountants - or the Supreme Court, which might be persuaded to revisit Central Bank. If the Court does so, it should offer a more satisfying distinction between "making" a fraud and "aiding and abetting" one than it has so far offered. .