The Enron Bank Shot

The lead agency charged by law to carry out the nation's securities laws has been left out in the cold -- although by law their views are entitled to special deference.
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"One deceit needs many others and so the whole house is built."
-Baltasar (1601)

We live in a funny country. In the same government, we have an agency to protect workers, an agency to protect investors, an agency to protect taxpayers, an agency to protect businesses. Sometimes they all do battle. Sometimes we all lose.

In a highly watched securities fraud case, at the direction of President Bush and urging of Treasury Secretary Henry Paulson, the Solicitor General of the United States declined to file a brief on behalf of investors in the United States Supreme Court. The reason cited was that private enforcement by victims of the federal anti-fraud statute could have a negative impact on the competitiveness of American business. The legal issue presented is whether third parties -- think investment banks -- can be held liable to victims when the banks are complicit in securities fraud -- think Enron.

This unusual decision by Solicitor General Paul Clement not to file a brief was taken despite a formal vote and recommendation by the Securities and Exchange Commission (SEC) to support investors before the high court. If the generally pro-business Supreme Court rules against such third party "scheme liability," it would mean a loss of many billions of dollars for Enron victims, whose lawsuit against six remaining investments banks could not go forward. Even more daunting, such a ruling could invite a wave of more fraudulent behavior by Wall Street banks since they would be immunized from lawsuits no matter how flagrant their actions. Finally, such a decision could also seriously undermine the SEC's ability to itself seek remedies against such fraudsters. For those reasons, the House Committee on Financial Services, chaired by Massachusetts Congressman Barney Frank, will next week investigate the where, who and especially why of this curious Justice Department decision to take a pass. All five SEC commissioners are scheduled to testify.

The specific case involved, Stoneridge, involves a cable company, Charter, alleged to have engaged in "round-tripping" -- using sham transactions with two suppliers to inflate revenues. Both Charter and the participating suppliers were sued for fraud for violating the securities statute prohibition against engaging in fraud through a "deceptive device" or an "illegal scheme."

The Enron victims have a parallel case. And on Monday, the Supreme Court is scheduled to decide whether also to grant review of a lower court decision rejecting "scheme liability" and tossing out their case as well. While the Solicitor General rejected the SEC decision to file a brief on behalf of victimized investors in Stoneridge, others were not so shy, including briefs by three dozen state attorneys general, the Council of Institutional Investors, and some of the nation's largest pension funds -- folks whose money is actually at risk from Wall Street shenanigans.

It is regrettable that the SEC has been left out of this discussion. Notwithstanding a ferocious lobbying campaign by big business, the SEC -- and Chairman, former Congressman (and once Merrill Lynch counsel) Chris Cox -- voted to support the victims of fraud. A third party, like a bank, the SEC reasoned, that engages in a sham transaction, like a phony loan, engages in "deception" and should be held accountable. So should someone that participates in an illegal "scheme" to defraud, even if behind the curtain. This is the long-held view of the SEC, including in the Enron trial court and in yet another case -- Homestore -- recently decided in favor of investors by the Ninth Circuit. Their opinion is well grounded in the precise words and more than 70 year history of our securities laws -- the best on earth. But now the SEC has been muzzled.

A little history is helpful here. The SEC was created as part of FDR's "New Deal." Responding to the excesses leading to the Great Depression, Congress did so in the early 1930's and created our landmark securities laws to punish all who participate in fraud -- liars and enablers alike. The Act, and its famous Rule 10b-5, prohibited anyone from engaging in fraud by a "deceptive device" or a dishonest "scheme." To most people, words like "deceptive" and "scheme" are clear enough. As the dictionary says, "deception" means "dishonesty," or "humbug," while a "scheme" is "a plot;" "a secret or devious plan;" "an underhanded conspiracy by trickery; e.g., a 'ponzi scheme'." Enron's banks did all of that - creating transactions to make loans look like income, "buying" Nigerian barges from Enron (to phantom Enron revenue), then selling them back at a guaranteed profit -- you get the idea. Classic fraud.

But not to the Wall Street banks -- or the Fifth Circuit judges who tossed the Enron case -- while, with surprising candor, acknowledging "our ruling on the legal merits may not coincide, particularly in the minds of aggrieved former Enron shareholders who lost billions of dollars . . . with notions of justice and fair-play." These "aggrieved Enron shareholders" had the temerity to rely on their bank and the market to be honest, robust and fair. They lost billions as a result. But there would be no day of reckoning. These victims will not even get the help of the SEC.

The Bush administration decision to quash the SEC brief before the Supreme Court on a case of this importance is without precedent. Certainly, the president can -- although he virtually never does -- personally decide what the Solicitor General should file before the Court. President Eisenhower is rumored to have actually edited the government's brief in Brown vs. The Board of Education. During the Carter administration, in the Bakke case, several federal agencies openly quarreled over the position Attorney General Griffin Bell eventually took. Realistically, the position taken by a Solicitor General before the Supreme Court will often reflect the views and policies of the administration in power.

That said, we are still a nation of law, not politicians. The Solicitor General's duty is ultimately to represent the people of the United States. And here, the lead agency charged by law to carry out the nation's securities laws -- the SEC wrote the regulation at issue -- has been left out in the cold -- although by law their views are entitled to special deference.

It is not as if this SEC is especially biased toward investors whose interests the Commission was created to protect. Quite the contrary -- the Chairman Chris Cox, while in Congress in 1995, led the effort to roll back federal laws protecting investors. Yet he and the Commission believe banks that participate in a fraudulent scheme should be held fully accountable in a court of law.

Why Treasury Secretary Paulson should be able to trump that SEC decision raises some tough questions, and it is now incumbent on Congress to get answers. (Paulson, previously Chairman of Goldman Sachs, once observed that "long term, we may look at Enron as a positive.") Why did the president of the United States personally involve himself in this particular case? At whose behest? What was the role of Attorney General Alberto Gonzales? What was the possible "anti-competitive impact" of enforcing laws enacted to prevent securities fraud and why was that even relevant to what the statute meant?

Still open is the possibility that later this summer the Solicitor General could choose in August to file against the investor victims and the SEC position, instead carrying the water of the nation's largest banks accused of fraud. They don't need the help.

Who speaks here then for Enron's victims, many of whom lost everything when banks like Merrill Lynch conspired with the crooks in Enron's board room to steal their life savings?

These matters are not just arcane issues of law or finance. They go to the core of our system of government. As more and more power is vested in corporations, banks, insurance companies and business generally, the "little guy" is left in more and more jeopardy of being trampled. Just as Enron trampled thousands of its own employees and millions of shareholders. The only recourse for such victims of greed and abuse is the government -- it is the essence of the social contract. Laws are enacted to insure them a fair shake -- and government and the courts are there to help when needed. But that contract has been repeatedly and grievously breached of late.

It has been breached when members of Congress vote not for the public interest but to protect the few and the powerful. It has been breached when government regulators come from the very industries they are supposed to regulate and instead give a wink and a nod. It has been breached when our law enforcers -- such as our United States Attorneys -- become political pawns instead of champions of justice. And it has been breached when big business uses the back door to the White House to get its views heard -- and followed. Someone needs to remind Steve Paulson he is Secretary of the Treasury -- the American people's treasury -- not the Secretary of Wall Street.

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