Guiltless by association
15 January 2007
The spectacular collapse of Enron in 2001 and the ensuing wave of private litigation included the predictable search by plaintiffs' attorneys for 'deep-pocket' defendants. As usual in such situations, the companies sued in various Enron litigations included a long list of financial institutions, accountants and law firms that had conducted a variety of business with the bankrupt company. Less predictably, the roster of defendants also included Alliance Capital (now known as AllianceBernstein), a leading US investment adviser that, in its client accounts, had sustained one of the largest Enron losses of any institutional investor.
From the outset Alliance maintained that the suits against it were without merit and that Alliance and its clients should be recognised as victims of fraud deserving redress. Over the following five years Alliance defeated five lawsuits, including class actions and a jury trial in the state court in Florida brought by the Florida State Employee Pension Fund, which was headed by Governor Jeb Bush, the Florida Attorney-General and the Florida Treasurer.
The pension fund had sought to recover $3.2bn (£1.64bn) in investment losses incurred in its account with Alliance, including a $300m (£153.29m) loss due to its Enron holdings alone. The jury, however, found in favour of Alliance, awarding Alliance its counterclaim for unpaid investment advisory fees.
In the latest chapter, the federal court in Texas, overseeing the massive class action brought on behalf of Enron shareholders, not only dismissed all claims against Alliance, but also awarded Alliance attorneys' fees - an unusual result in the US, where parties are usually left to bear their own legal costs. Even more unusual is the fact that the award of fees was made not against the plaintiffs (which included the managers of several institutional pension funds led by the Regents of the University of California), but against the plaintiffs' counsel, US securities class action firm Lerach Coughlin Stoia Geller Rudman & Robbins.
The claim against Alliance in the Texas action, which was brought under Section 15 of the Securities Act of 1933, expressly disclaimed any allegation of fraud against Alliance. Instead it alleged that Frank Savage, an employee of Alliance who also served on Enron's board of directors, was liable under Section 11 of the Securities Act because he had signed one of Enron's financial statements later found to contain inaccurate and misleading information.
Section 15 provides for liability, without the necessity of any fraudulent intent, on the part of any person who controls the primary violator under Section 11, unless the controlling person establishes that it had "no knowledge of or reasonable ground to believe in the existence of" the facts that are the basis of the alleged liability.
The plaintiffs alleged that Alliance had placed Savage on Enron's board of directors in order to safeguard Alliance's interest as a large institutional shareholder of Enron and that Alliance had the power to control Savage in his activities as an Enron director. While acknowledging that the allegations against Alliance appeared "somewhat speculative", the court initially allowed the plaintiffs claims to go forward, finding that Alliance's objections would be more properly made at the summary judgment stage.
That ruling meant that the case against Alliance continued for several years of costly discovery, which is customary in complex US litigation. In the course of discovery, plaintiffs took several days of deposition testimony from Savage, who denied steadfastly both any knowledge of the fraud at Enron and any effort to serve the interests of Alliance on the Enron board. Savage testified without contradiction that he had approached Alliance for permission to accept an invitation to join the Enron board, that Alliance gave such permission only after he agreed to abide by a Chinese wall separating him from involvement in any Alliance business concerning Enron, that he had never given Alliance any inside information concerning Enron, and that no one at Alliance had ever asked him for such information. The plaintiffs did not seek to take the testimony of any other Alliance personnel.
At the conclusion of fact discovery, Alliance moved for summary judgment, on the grounds that there was no evidence from which a reasonable jury could find that Alliance had the power to control Savage's actions as an Enron director. Alliance also sought an assessment of counsel fees and costs under Section 11(e) of the 1933 act, a little-used provision that permits such an assessment if the court finds the losing party's claim or defence to have been without merit.
Despite the paucity of evidence, the plaintiffs opposed the motion for summary judgment, arguing that Alliance had the power to control Savage by virtue of being his employer, that Alliance could be deemed to have 'placed' Savage on the Enron board because it could have withheld its permission for him to accept the seat, and that in various instances the Chinese wall had been breached. For example, the plaintiffs pointed to an elevator encounter between Savage and a research analyst who covered Enron for Alliance shortly after the public announcement of the proposed merger between Enron and Dynegy, in which Savage agreed with the analyst that the proposed merger was "a good deal".
The court found these arguments unpersuasive. The court noted that, in federal courts in Texas, employment status alone was not sufficient proof of the power to control for purposes of finding liability under Section 15, and that discovery had failed to produce any evidence that Alliance ever sought to control Savage's actions on the Enron board. The court further observed that there was no evidence that Alliance, or indeed Savage, knew or had reason to know about the fraud at Enron - a complete vindication of Alliance.
A false claim
In deciding to grant Alliance's request for counsel fees and costs, the judge held that at some point during discovery it became clear that the claim against Alliance was false and that "the summary judgment briefing should not have been necessary and the continuance of the claim against Alliance was at that point without merit".
Moreover, adopting Alliance's argument invoking Section 11(e)'s fee-shifting provision (a less strict version of the 'loser pays' rule featured in UK tort law), the court took the unusual step of awarding Alliance its fees and costs relating to the summary judgment stage of the litigation and held that the award should be made against the plaintiffs' counsel rather than their clients, because "non-attorney clients more likely than not would not have the ability to determine at what point, and based on what evidence, an action becomes legally 'frivolous', while its licensed counsel should and is held to such a standard".
The final act of the drama on 20 December 2006 included still another unusual development - a public apology by the unsuccessful plaintiffs. The lead plaintiffs, the Regents of the University of California, issued a press release announcing that, although the university's counsel had believed in good faith that there was sufficient evidence "to submit the matter to the court for resolution, the university regrets that it continued to pursue litigation against Alliance Capital under these circumstances".
Mark Kirsch is chair of US litigation and dispute resolution and James Moyle is a partner at Clifford Chance