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(Article from Securities Law Alert, May/June 2019) 

For more information, please visit the Securities Law Alert Resource Center

On May 24, 2019, the Fifth Circuit affirmed dismissal of an Enron-related securities fraud action brought against the independently–incorporated retail brokerage and investment banking arms of a major bank. Lampkin v. UBS Fin. Servs., 2019 WL 2240568 (5th Cir. 2019) (Higginbotham, J.). The brokerage managed Enron’s employee stock option plan, while the investment bank advised Enron on a number of transactions. The Fifth Circuit held that the grant of stock options pursuant to the employee stock option plan was not a “sale” of securities, as required to state a claim under Sections 11 and 12 of the Securities Act of 1933 (the “Securities Act”). The court reasoned that “[t]he employees did not bargain for the options and they were granted for no cash consideration.” With respect to plaintiffs’ claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, the Fifth Circuit found plaintiffs failed to allege a joint venture between the brokerage and the investment bank, and therefore the brokerage had no duty to disclose to its clients the investment bank’s alleged knowledge of Enron’s financial fraud.

Grant of Stock Options Pursuant to a Compulsory Employee Stock Option Plan Is Not a “Sale”

The Fifth Circuit explained that a sale of securities is a prerequisite for a claim under Sections 11 and 12 of the Securities Act, as both provisions “expressly limit liability to purchasers or sellers of securities.” The court noted that in International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America v. Daniel, 439 U.S. 551 (1979), the Supreme Court held that “‘participation in a noncontributory, compulsory pension plan’ is not the equivalent of purchasing a security” because “the ‘purported investment is a relatively insignificant part’ of the employee’s total compensation, and the decision to accept and retain employment likely had only an attenuated relationship to the investment.” Lampkin, 2019 WL 2240568 (quoting Daniel, 439 U.S. 551). Following the Court’s ruling in Daniel, the SEC issued a release clarifying that “plans under which an employer awards shares of its stock to covered employees at no direct cost to the employees” do not result in “sales” within the meaning of the Securities Act.[1]

The Fifth Circuit recognized that, “[c]onsistent with the interpretations of the SEC, courts have extended Daniel to compulsory and involuntary employee stock option plans.” The court explained that “[a] hallmark of a voluntary plan is the ability of the employee to make an investment decision to acquire the stock options.” The court noted that the key inquiry under Daniel is “whether employees made an investment decision that could be influenced by fraud or manipulation.”

Applying Daniel, the Fifth Circuit held that plaintiffs “failed to demonstrate that the grant of Enron options amounted to the sale of a security,” as required for a Securities Act claim. The court reasoned that “participation in the [plan] was compulsory and employees furnished no value, or tangible and definable consideration in exchange for the option grants.” The court found that it was “of no consequence” that plaintiffs “would eventually make an affirmative investment decision—whether to exercise the option or let it expire,” since plaintiffs’ claims were “based explicitly on the grant of the option, not the exercise of that option.”

Plaintiffs Failed to Allege the Existence of a Joint Venture Between the Brokerage and the Investment Bank

Plaintiffs alleged that the brokerage and the investment bank “united in a joint venture” that “owed a duty to its retail brokerage clients . . . to disclose information that Enron manipulated and materially misstated its financial results to the public.” According to plaintiffs, “any material, nonpublic information known to [the investment bank] had to be disclosed by [the brokerage]” because the bank “operated as a single, fully integrated entity.”

The Fifth Circuit rejected plaintiffs’ joint venture theory of liability. In so holding, the court found “persuasive” the reasoning in Giancarlo v. UBS Financial Services, 725 F. App’x. 278 (5th Cir. 2018), an unpublished decision involving the same defendants in a different Enron-related case. As in Giancarlo, the Fifth Circuit found that “‘vague corporate platitudes about integration as a firm’ are insufficient to support a finding of joint venture liability.” Id. (quoting Giancarlo, 725 F. App’x. 278). The Fifth Circuit emphasized that plaintiffs did not allege “that defendants shared profits or losses” or “that defendants had joint control or right of control over the joint venture,” as required to establish the existence of a joint venture under governing Delaware law. The court further found that plaintiffs did not assert any other theory pursuant to which it could “aggregate the actions and knowledge of the defendant entities for purposes of assessing liability.” The Fifth Circuit concluded that plaintiffs failed to state a claim under Section 10(b) and Rule 10b-5 since there were no allegations that either the brokerage or the investment bank had both material nonpublic information and a duty to disclose that information.