Breaking Past the Parallax: Finding the True Place of Lawyers in Securities Fraud

By Adams, Marianne C. | Fordham Urban Law Journal, October 2010 | Go to article overview
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Breaking Past the Parallax: Finding the True Place of Lawyers in Securities Fraud

Adams, Marianne C., Fordham Urban Law Journal


   I. Background
      A. Cast in Dual Roles: The Role of the Lawyer
        1. Professional Rules Governing Attorney Conduct
        2. Attorneys as Gatekeepers
      B. The World Before Central Bank
      C. Central Bank and the Congressional Response it Prompted.
      D. Enron and Sarbanes-Oxley
      E. The Supreme Court Weighs In Again: Stoneridge v.
      F. Recent Congressional Action

 II. The Parallax View: Too Much, Or Not Enough, Liability On
     Lawyers Is A Matter Of Perspective
     A. Arguments for Liability
        1. The Gatekeeper Argument
        2. The Deterrence Argument
        3. The Compensation Argument
        4. The Client Protection Argument
     B. The Anti-Liability Side: "Clients [W]ant [C]hampions,
        [N]ot [C]haperones"
        1. The Strict Reading of Statutory Text Argument
        2. The Attorney-Client Privilege/Confidentiality
        3. The Floodgates of Litigation Argument
        4. The Bubble Theory and Increased Costs for Gatekeeper
        Services Arguments
III. In Search of the Middle: What Role Should a Lawyer Really
     Play, And What Level Of Liability Meets the Goals of
     A. Proposed Solution
        1. Strengths of the Proposal
        2. Weaknesses of the Proposal
     B. Existing Proposals
        1. Return to pre-Central Bank
        2. Restoring a Private Right of Action with a Cap on
        3. Professional Rules Solution
        4. Other Proposed Solutions


In October 2005, investors discovered that Refco, Inc., a popular brokerage firm, had for years engaged in fraudulent transactions designed to create a semblance of financial success. (1) To cover up, rather than write off, poorly made loans that became uncollectible, Refco engaged in a series of complex "round-trip" transactions in which it made loans to third-parties and then had the third-parties make loans to its entities. (2) As a result of this scheme, the appearance of Refco's balance sheets improved dramatically. No one was the wiser when the company went public until months later when Refco stated that its balance sheets should not be relied upon. (3) As it turned out, Refco's financial situation, covered up by the fraud, left it on the precipice of collapse, which imminently followed, (4) causing tremendous losses to investors and forcing Refco to declare bankruptcy. (5)

In the course of its "round-trip" fraud, Refco used a well-known law firm to help it prepare key documents (6) and explain the structure of the "round-trip" transactions to third-party participants in the scheme. (7) The law firm was also involved in the creation of a series of securities offerings in which the prospectuses contained information that it knew to be false. (8) Not surprisingly, investors sued the law firm claiming that it knew or should have known about the fraud, and thus ought to be held liable. (9) The firm moved for dismissal. (10) Granting the motion to dismiss, United States District Court Judge Lynch wrote that, given the present state of the law, he had no choice but to dismiss the action against the law firm. (11) In dicta, however, Judge Lynch expressed his concern with the laws under which he had to decide the case, as well as his opinion that the system is ripe for a change so that such actions could, at a minimum, be heard in court. (12)

Lawyers often play an integral part in business transactions and securities offerings. This puts lawyers on the sidelines of not only great business successes, but also, every so often, tremendous failures. (13) Because they are viewed by many as gatekeepers, and in that role provide a degree of assurance (with their reputational capital) that gross illegalities will not occur, (14) a series of questions arise in the minds of many when illegalities do happen on attorneys' watch.

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Breaking Past the Parallax: Finding the True Place of Lawyers in Securities Fraud


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