Federal Court Awards Fees and Costs under 11(e) Against Plaintiff's Law Firm

In what may be a case of first impression, a federal judge (SD Tex) has assessed fees and costs under Section 11(e) of the Securities Act against the plaintiff’s law firm. The case involved an Enron outside director who was also a senior official at a financial services company. It was alleged that the director was liable under Section 11 for signing Enron’s false registration statement filed with the SEC and that the financial services company was also liable as a controlling person of the director. The court found that the fact that the financial services company employed the director was not enough to establish the power to control his role as an independent director. An award of fees and costs under Section 11(e) is conditioned on a finding that the action was without merit, that it was frivolous or brought in bad faith. Newby v. Enron Corp., 01-cv-03624, 11-30-06, Judge Harmon.

The court went on to award fees and costs to the financial services company related to the summary judgment stage of the litigation because it appeared that the summary judgment briefing should not have been necessary and the continuance of the claim at that point was without merit. The court also reasoned that an award of fees and costs under Section 11(e) should be borne by counsel because non-attorney clients more likely than not would not have the ability to determine at what point, based on what evidence, an action becomes legally frivolous, while its counsel should.

This opinion is also important on another level. In the post-Sarbanes-Oxley era, independent outside directors are critical to sound corporate governance and there is concern that there may not be enough good ones. Importantly, the court said that, if mere approval of a corporate officer’s request to serve as an outside director on another company’s board would be held to be control person liability, the effect would be to chill the willingness of qualified individuals to serve on boards of public companies as independent directors. This result would be a detriment to business, and the court could not countenance it.