This article is part of the PLC Global Finance September e-mail update for the United States.
In the recent case of Stoneridge Investment Partners v Scientific-Atlanta, the US Supreme Court reaffirmed the position it took in the Central Bank case in 1994, where it ruled that Section 10(b) of the Securities and Exchange Act of 1934 did not provide for a private right of action against those who aid and abet another's violation of the securities laws. The two cases limit the liability of secondary actors for misrepresentations or omissions in materials relating to securities transactions. However, in a spate of recent cases, the SEC and plaintiffs bar have now launched another offensive to dramatically expand the scope of liability by circumventing the bright-line rule announced in Stoneridge. Some of these attempts have met with some degree of success. This article considers a few of the leading ones and their implications.Close speedread
In 1994, the US Supreme Court in the Central Bank case ruled that Section 10(b) of the Securities and Exchange Act of 1934 (Exchange Act) did not provide for a private right of action against those who aid and abet another's violation of the securities laws. For a time, this decision ensured that "secondary actors" would not be subject to civil liability under Section 10(b) for any misrepresentations or omissions contained in those materials. Secondary actors include:
Bankers, accountants and lawyers, who play a supporting role in the preparation of an issuer's financial disclosures.
Counterparties to commercial transactions that an issuer includes in its financial disclosures.
Eventually, however, the SEC and private claimants proffered creative new theories designed to circumvent the Central Bank's limit on liability. Chief among these new theories was "scheme liability." Under this theory, claimants would recast a misrepresentation or omission (for which only the actual speaker could be held liable) as a "scheme" to make a misrepresentation or omission. Claimants would then allege that anyone who played any role in the scheme could be held liable as a primary violator of Section 10(b).
After much debate in the lower courts about the viability of this approach, the Supreme Court took up the issue in Stoneridge Investment Partners, LLC v Scientific-Atlanta, Inc., 552 U.S. 148 (2008) (Stoneridge). There, the Court rejected scheme liability, holding that to allow it would permit a finding of liability in a circumstance where claimants did not rely directly on anything the defendant said or did. Because direct reliance is an essential element of a Section 10(b) claim, liability could not follow in those circumstances.
Although many assumed that the Court's decision in Stoneridge would end the debate regarding the liability of secondary actors under Section 10(b), the SEC and the claimants' bar have now launched another offensive to dramatically expand the scope of liability by circumventing the bright-line rule announced in Stoneridge.
Unfortunately for defendants, these efforts have initially met with some success.
In In re HealthSouth Corporation Securities Litigation (257 F.R.D. 260 (N.D. Ala. 2009)), a district court ruled that holders of a company's common stock could assert Section 10(b) claims against UBS, which acted as underwriter of a Rule 144A offering of HealthSouth bonds, even though the bonds were only offered to qualified institutional investors (QIBs).
In the case, UBS argued, among other things, that:
Any misrepresentations in the offering materials could not be attributable to UBS (per Central Bank and Stoneridge).
Other statements made by UBS in connection with offering the securities were private comments not disseminated to the general public.
The Court rejected the UBS's arguments, holding that the underwriter made false representations to the market about the issuer's financial condition: because its name appeared on the cover of the offering materials, UBS was lending its "good name" to the offering. The Court found that UBS made a "statement" to the effect that "these bonds are good enough for [us], so they must be good enough for you."
In addition, the Court ruled that the underwriter could be held primarily liable because its activities (including the dissemination of the private offering materials) indirectly affected the market for the company's common stock (among other reasons, the QIBs that were offered the bonds were also "significant participants" in the market for the company's common stock).
Somewhat similarly, in SEC v Tambone (550 F.3d 106 (1st Cir. 2009)), a federal appellate court decided that employees of an underwriter could be held primarily liable for misrepresentations made in prospectuses even though they were neither drafted by the underwriter's employees nor attributed to them.
In that case, the SEC as the claimant argued that because the defendants had a duty to confirm the accuracy of the prospectuses, they could be held primarily liable because they both:
"Adopted" the allegedly false statements made by others when they used the prospectuses to market the securities.
Made an "implied statement" to potential investors that they had a reasonable basis to believe the statements made in the prospectuses were truthful.
Although the court did not address the SEC's "adoption" theory, it did embrace its "implied statement" theory, holding that an underwriter's role and duties are such that it can be viewed as having made "an implied statement without actually uttering the words in question" and that the underwriter's employees' conduct was therefore actionable under Section 10(b).
The appellate court has since agreed to re-hear the case en banc in mid-October and has vacated the above decision.
In In re Mutual Funds Investment Litigation (566 F.3d 111 (4th Cir. 2009)), the Fourth Circuit adopted a standard that, like Tambone, cast a wide net for liability under Section 10(b).
There, the claimants sought to hold an investment advisor, among other defendants, primarily liable for misstatements in mutual fund prospectuses that were not publicly attributed to them.
According to the claimants, the defendants should be held responsible for these misstatements because, as a "practical matter," it was obvious that they "run" the funds and consequently, the public would likely attribute the misstatements to defendants.
The Court agreed. It explained that at the pleading stage, a claimant need only allege facts from which a court "could plausibly infer that interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributed to defendant."
Although the courts in these cases accepted the SEC's and claimants' expansive reading of Section 10(b), the district court in In re Refco, Inc. Securities Litigation (609 F. Supp. 2d 304) refused to do so.
In that case, the Court was asked to decide whether a law firm could be held primarily liable for misstatements made in offering materials when the firm was mentioned only as counsel for the issuer and none of the allegedly false statements made in the documents were attributed to it. The Court correctly held that the firm could not, explaining that "[t]o rise to the level of a primary violation . . . the misrepresentation must be attributed to the specific actor at the time of public dissemination."
The claimants have appealed this decision to the Second Circuit and, in connection with that appeal, the SEC has submitted an amicus brief urging the Court to adopt a slightly modified version of the previously-rejected "scheme" theory of liability.
In particular, the SEC asserts that liability under Section 10(b) should not be limited to those to whom a statement is explicitly attributed. Rather, civil liability should extend to anyone who "created" the statement at issue. According to the SEC, a statement is "created" by a person "if the statement is written or spoken by him, or if he provides the false or misleading information that another person then puts into the statement, or if he allows the statement to be attributed to him."
The current debate over the limits prescribed by Stoneridge may prompt the Supreme Court or Congress to address the issue. Indeed, Senator Arlen Specter has recently introduced a bill, S. 1551, entitled the 'Liability for Aiding and Abetting Securities Violations Act of 2009,' which would expand civil liability under Section 10(b) to cover "any person that knowingly or recklessly provides substantial assistance to another person" who commits securities fraud.
Until that bill passes or the Supreme Court weighs in, "secondary actors," including lawyers, accountants and financial institutions, should expect continued efforts by the SEC and claimants to blur the distinction between primary liability and aiding and abetting.