On February 26, 2018, the United States Court of Appeals for the Fifth Circuit affirmed in a per curiam unpublished decision the dismissal of a putative securities class action against UBS AG and certain affiliated entities. Giancarlo, et al. v. UBS Financial Services Inc., et al., No. 16-20663 (5th Cir. Feb. 26, 2018). Plaintiffs—former clients of a defendant UBS affiliate who invested in former energy giant Enron using the UBS affiliate as their broker—alleged that defendants violated Section 10(b) of the Securities Exchange Act by failing to disclose information purportedly revealing problems with Enron’s accounting, leading to alleged losses when Enron’s precarious financial position was uncovered in November 2001. The United States District Court for the Southern District of Texas dismissed plaintiffs’ claims, finding that plaintiffs failed to plead facts demonstrating that defendants’ separate corporate status should be disregarded, and thus had failed to adequately plead their “single, fully integrated entity” theory of liability. The District Court further found that plaintiffs had failed to identify specific brokers or allege facts demonstrating that each broker had an intent to deceive, manipulate, or defraud. The Fifth Circuit agreed, holding that plaintiffs had failed to meet the heightened specificity requirements for pleading securities fraud under Federal Rule of Civil Procedure 9(b), noting that plaintiffs had not adequately alleged that defendants had knowledge of Enron’s practices, nor a duty to disclose such information to plaintiffs.

In affirming the district court’s decision, the Fifth Circuit first considered whether plaintiffs adequately alleged that the defendants—related but distinct corporate entities—constituted a joint venture, which might permit the Court to aggregate the defendants’ knowledge for the purpose of assessing the sufficiency of alleged knowledge and intent to deceive. In part based on statements in SEC filings referring to defendants as an “integrated investment services firm” and calling UBS an “integrated group,” plaintiffs argued that each defendant’s actions could be attributed to a single broad UBS entity because the UBS affiliated entities formed a “de facto joint venture.” Applying Delaware law, the Court found that despite defendants’ “vague corporate platitudes about their integration as a firm,” the allegations were insufficient to establish a joint venture. The Court noted that none of plaintiffs’ allegations alluded to profit sharing or loss sharing or supported any other theory permitting aggregation of defendants’ knowledge, which are relevant factors considered under Delaware law.

The Fifth Circuit then considered whether defendants were in possession of and had a duty to disclose allegedly material, nonpublic information about Enron’s financial statements. The Court emphasized that while plaintiffs made allegations concerning “UBS’s knowledge,” that broad invocation of a combined entity was insufficiently particular to meet the heightened pleading requirements to state a securities fraud claim. The Court then addressed and rejected each of plaintiffs’ purported sources of a duty to disclose on behalf of UBS. First, the Court considered whether applicable self-regulatory organization rules imposed a duty of disclosure on any of the defendants, and noted that the only rule raised in plaintiffs’ allegations was a National Association of Securities Dealers rule requiring members to communicate based on “fair dealing and good faith.” The Court noted that the rule does not impose a duty of disclosure in the absence of a communication, and that plaintiffs had not alleged with specificity that any person at any defendant who communicated with plaintiffs had material, nonpublic information concerning Enron. Thus, the Court held that, even if a defendant entity had a duty of disclosure under the rule, plaintiffs had not shown with sufficient particularity that defendants violated that rule.

Plaintiffs also cited the United States Supreme Court’s decision in Affiliated Ute Citizens of Utah v. U.S., 406 U.S. 128 (1972), for the proposition that defendants’ “special relationship” with plaintiffs gave rise to a fiduciary-like duty of disclosure. The Court, however, found that the relationship between plaintiffs and defendants was unlike the relationship at issue in Affiliated Ute because other market makers and underwriters were trading in Enron securities and plaintiffs were not required to deal with any of the defendants. The Court also rejected plaintiffs’ contention that their retail relationship with defendants gave rise to a duty of disclosure, noting that even if it did, plaintiffs still had not demonstrated that the entity with which they communicated had any material, non-public knowledge to disclose. Accordingly, the Court found that the district court had properly dismissed plaintiffs’ amended complaint for failure to state a claim.

Finally, the Court turned to whether the district court had properly dismissed plaintiffs’ first amended complaint without granting leave to file a second amended complaint. Plaintiffs argued that the district court abused its discretion by denying leave to amend, and further argued that plaintiffs had failed to timely amend their complaint because they were waiting to receive additional information from the testimony of Enron’s CFO and UBS’s expert witness. The Fifth Circuit rejected plaintiffs’ explanations, finding that they did not explain plaintiffs’ years-long delay in filing leave to amend even after obtaining that information, and that plaintiffs had not demonstrated that additional allegations could cure the deficiencies in the amended complaint.

This decision underscores the heightened pleading standards that plaintiffs must meet to establish a securities fraud claim, and the specificity requirements for pleading scienter in cases with multiple defendants that are separate but related entities. Where plaintiffs do not specify which individuals or entities were responsible for particular alleged material misstatements or omissions in support of a securities fraud claim, courts may dismiss those actions for failure to state a claim.

Giancarlo, et al. v. UBS Financial Services Inc., et al.