The Fifth Circuit recently issued this opinion that examines the investor reliance presumption under the fraud on the market theory in securities litigation. Under that theory, investors are entitled to a presumption that they relied on a misrepresentation so long as the company’s shares were traded on an efficient market. An interesting twist to that theory is that the investors are not entitled to the presumption if they cannot establish that the misrepresentation actually affected the market price of the stock.
In this particular case, the plaintiffs apparently could not prove that the defendants’ positive public statements regarding the company (which turned out to be false) had increased the company’s stock price. Accordingly, the Fifth Circuit reasoned that the plaintiffs were entitled to the presumption of reliance only to the extent that they could tie the earlier false positive statements to the subsequent decline in stock price after the true negative public statements hit the media. The Fifth Circuit observed:

We are satisfied that plaintiffs cannot trigger the presumption of reliance by simply offering evidence of any decrease in price following the release of negative information. Such evidence does not raise an inference that the stock?s price was actually affected by an earlier release of positive information. To raise an inference through a decline in stock price that an earlier false, positive statement actually affected a stock?s price, the plaintiffs must show that the false [positive] statement causing the increase was related to the statement causing the decrease. Without such a showing there is no basis for presuming reliance by the plaintiffs.

This is yet another in a long line of Fifth Circuit decisions that require strong proof of reliance in fraud cases. Hat tip to the Rule 10b-5 Daily for the link to this decision.

This Chronicle story reports on an interesting development in the Enron-related criminal case commonly referred to as the “Nigerian Barge case.” U.S. District Judge Ewing Werlein rejected one of the defendants’ request for a postponement of a July trial setting to allow the defendants additional time to sift through over 2 million pages of documents relating to the case. Consequently, for the first time since the controversial Arthur Andersen trial over two years ago, it now appears that the Enron Task Force is actually going to have to try a case.
The Nigerian Barge case is a particularly interesting one because it involves the government’s attempt to convict former Enron and Merrill Lynch executives of participating in a commercial transaction of the type that is common throughout the business world. The Enron Task Force contends that the entire Nigerian Barge deal in which Enron sold an interest in some barges off the coast of Nigeria to Merrill Lynch was a sham because Merrill Lynch would not have done the deal but for former Enron CFO Andrew Fastow‘s oral assurance that Enron would broker a sale of the barges for Merrill Lynch the following year. Fastow did indeed broker a sale of the barges the following year to one of his infamous “off-balance sheet partnerships” that hid roughly $40 billion of Enron debt.
According to the government’s theory, if Fastow’s oral assurance to Merrill Lynch was binding on Enron, then the sale of the barges was not a true arm’s length sale and, as a result, Enron’s accounting for the transaction as a true sale was fraudulent. Under the government’s theory, the fact that the written agreements entered into between Enron and Merrill Lynch contained a provision that made Fastow’s oral assurrance unenforceable is irrelevant. The contract was false and a part of the sham because Merrill Lynch would not have done the deal but for Fastow’s oral assurances.
Other than Mr. Fastow’s probable testimony of dubious credibility (he is cooperating with the government under a draconian plea bargain in an attempt to minimize his jail time to ten years), the government’s primary evidence of the alleged sham nature of the deal appears to be the “nervousness” that several Merrill executives openly expressed about the deal in emails prior to Merrill consummating the transaction. The government interprets that nervousness as evidence that the Merrill executives knew that the deal was a sham and that they could be caught participating in a fraud with Enron.
However, there is another (and in my mind, more reasonable) interpretation of Merrill’s nervousness regarding the deal — that is, they were really nervous about the deal, not because they thought it was a sham and a fraud, but because they knew that they could not rely on Fastow’s oral assurance that Enron would broker a sale of the barges the following year. Accordingly, their nervousness was that they might be making a bad investment that would result in having to hold the barges for a long, rather than short, term. Stated another way, the Merrill executives were nervous because they knew that this was a real deal in which the deal documents controlled the rights of the parties, and that Fastow’s oral assurances to get them to do the deal could not be enforced if Enron failed to live up to them.
The Chronicle also has this piece today on the Enron grand jury in Houston and its members’ cozy relationship with the Enron Task Force attorneys.