In Affco Investments 2001 LLC v. Proskauer Rose L.L.P., No. 09-20734, 2010 WL 4226685 (5th Cir. Oct. 27, 2010), the United States Court of Appeals for the Fifth Circuit held that a law firm which allegedly assisted in developing a fraudulent tax shelter scheme could not be held liable under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, for conduct and statements not explicitly attributed to it. In the absence of such express attribution, the Court held, the investor plaintiffs could not demonstrate reliance upon the law firm in deciding whether to invest. This decision echoes a recent, similar ruling by the Second Circuit establishing a "bright line" rule limiting liability of secondary actors only to instances where conduct or statements are expressly attributed to them.
According to plaintiffs' amended complaint, the accounting
firm of KPMG, LLP ("KPMG") targeted and solicited
plaintiffs for participation in a tax shelter involving investment
in LLCs specially created for that purpose. In its soliciting
materials, KPMG represented the scheme as "a legitimate
investment vehicle as well as a legitimate tax shelter," and
promised to provide investors with independent opinions from
"several major national law firms" that had analyzed and
approved the tax strategy. Based on these assurances, plaintiffs
agreed to invest. After plaintiffs' invested, they received an
opinion letter from the law firm of Sidley Austin Brown & Wood,
LLP that the IRS would likely condone the tax scheme. Later, in
response to an IRS notice regarding so-called "prohibited
transactions," plaintiffs sought — and received
— tax opinions from Proskauer Rose LLP
("Proskauer") concluding that the KPMG transactions were
not substantially similar to the "prohibited
transactions" noticed by the IRS, and that plaintiffs did not
need to disclose their involvement in the tax scheme on their tax
returns. The IRS eventually audited plaintiffs, fining them several
millions of dollars for their participation in an abusive tax
shelter.
Plaintiffs sued KPMG and other alleged participants in the tax
scheme, including the law firms, alleging violations of, inter
alia, Section 10(b) and Rule 10b-5. Proskauer, the only
defendant that did not settle, moved to dismiss, arguing (among
other things) that plaintiffs could not demonstrate reliance upon
the Proskauer opinions since they received the opinions only after
they invested. The district court granted the motion, holding that
plaintiffs failed to plead the elements of reliance and scienter
against Proskauer in connection with the scheme.
On appeal, plaintiffs argued that Proskauer could be held liable
"for participating in the creation of a false statement or
misrepresentation that investors rel[ied] upon, regardless of
whether that statement [was] attributed to [Proskauer] at the time
of dissemination." Specifically, plaintiffs alleged that
"law firms (such as Proskauer . . . ) . . . [worked with KPMG]
to promote, sell, and support the tax strategies on a broad
scale"; that KPMG's "associations with Proskauer, . .
. and others allowed [it] to offer skeptical taxpayers the
assurance that the strategies had been reviewed and approved in
'independent' tax opinions from several major national law
firms"; that a partner at Proskauer worked with KPMG "to
refine the tax strategies, review the marketing materials, and
create model template opinions addressing the tax consequences and
reporting requirements of the tax transactions"; that
"the strategy contemplated that the taxpayer would receive one
or more of these opinions from his choice of four firms, including
Proskauer"; that KPMG assured plaintiffs that "several
major national law firms had also vetted the [tax scheme] and could
provide [p]laintiffs [with] an 'independent' opinion
corroborating KPMG's representations"; and that plaintiffs
agreed to the deal based in part on "the assurance that
national law firms such as Proskauer . . . were prepared to provide
opinions supporting the [tax scheme]."
Citing the United States Supreme Court decisions in
Stoneridge Investment Partners, LLC v.
Scientific-Atlanta, Inc., 552 U.S. 148 (2008)
[see blog article here], and Central Bank of Denver, N.A. v. First
Interstate Bank of Denver, N.A.., 511 U.S. 164 (1994),
the Fifth Circuit held that because Proskauer was never
specifically identified as participating in the alleged scheme,
plaintiffs could not demonstrate that they relied upon Proskauer in
advance of their investment. The Court followed the recent,
factually analogous decision by the Second Circuit in Pacific Investment Management Co. LLC v.
Mayer Brown LLP, 603 F.3d 144 (2d Cir. 2010)
[see blog article here]. In Pacific Investment,
a corporation's outside counsel was accused of creating and
disseminating material misrepresentations on behalf of the
corporation. There, the Second Circuit held that the law firm could
be held liable in a private Section 10(b) action only for false
statements expressly attributed to that secondary actor at the time
of dissemination, and that "[a]bsent attribution, plaintiffs
cannot show that they relied on defendants' own false
statements, and participation in the creation of those statements
amounts, at most, to aiding and abetting securities
fraud."
The Fifth Circuit, finding Pacific Investment persuasive,
ruled that "explicit attribution [was] required to show
reliance under section 10(b)." While the Affco
plaintiffs' allegations painted "a clear picture of
Proskauer's intimate involvement in the tax scheme," the
plaintiffs' scrupulous avoidance of "any explicit
assertion that they had knowledge of Proskauer's role prior to
their actual investment in the tax scheme," and failure to
allege either that "they ever saw or heard any Proskauer work
product before making their decision," or that KPMG
"specifically identified Proskauer as one of the 'major
national law firms' that had vetted and cleared the tax scheme
or that had agreed to provide opinions supporting the same,"
fell short of the "explicit attribution" required to
implicate secondary actors making material
misrepresentations.
According to the Fifth Circuit, "[k]nowing the identity of the
speaker is essential to show reliance because a word of assurance
is only as good as its giver." Thus, even though KPMG
advertised support from "major national law firms," this
representation was not a sufficient showing that the Affco
plaintiffs relied on Proskauer itself. Affco and
Pacific Investments thus establish a "bright
line" rule that reinforces the Supreme Court's limitation
of liability of secondary actors under Section 10(b).
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