Securities Fraud
Defendants
Aiding and abetting
“Primary violator”
Control perons
(last updated 24 Apr 12)
Central Bank v. First Interstate (US 1994)
Bond investors
sue
Central Bank
(indenture trustee)
bonds
Annual
report
Underwriter
Board of
directors
Public Building
Authority
(Issuer)
AmWest
(developer)
appraisal
Assessment
liens
Holding:
“…
statutory language, ‘the starting
point in every case involving
construction of a statute.”
Any person or entity, including
• We
presume
Congressorwould
a lawyer,
accountant,
bank,
have
used the awords
“aid” and
who employs
manipulative
“abet”
device or makes a material
• Statute prohibits only the
misstatement
(or omission)
on
making
a material
misstatement
which
a purchaser or seller of
(or
omission)
securities
relies
may be liable
• [Other
liability
provisions
under
’33
do notviolator
include …
aiders
as Act
a primary
and abettors]
• Allowing the plaintiff to
circumvent the reliance
requirement would circumvent
the careful limits on 10b-5
recovery
Justice Anthony
Kennedy
Apply Central Bank …
Central Bank v. First Interstate (US 1994)
Bond investors
sue
Central Bank
(indenture trustee)
bonds
Annual
report
Underwriter
Board of
directors
Public Building
Authority
(Issuer)
AmWest
(developer)
appraisal
Assessment
liens
Press Release:
The company is today announcing its year-end
financial results, which continue to look favorable.
***
• Auditor
– Release omits to state that auditor has doubts about
financials, which are not audited
– In fact, no mention of auditor, which had advised that
financials actually “NOT favorable”
• Lawyer
– Release omits to state that lawyer who helped draft
the press release aware that results unfavorable
– In fact, no mention that lawyer threatened a “noisy
withdrawal”
Scheme liability …
Stoneridge Inv v. Scientific-Atlanta (US 2008)
Purchasers
(Stoneridge)
Quarterly
reports
Executives
Charter
Communications
(Issuer)
Arthur Andersen
(Auditor)
Book ad revenue
Capitalize boxes
Sham transactions
box purchases
 advertising
Scientific-Atlanta
Motorola
(customer/suppliers)
Holding:
Reliance by plaintiff upon the
defendant’s deceptive acts is an
essential element of the S 10(b) private
cause of action.
[Reliance excused only when duty to
disclose or fraud on market.]
[If assume reliance by investors on
transactions that financials reflect, 10b5 liability] would reach the whole
marketplace in which the company
does business, and there is no authority
in the rule.
The suppliers deceptive acts are too
removed to satisfy the requirement of
reliance. [See federalism concerns;
Congress extends aiding and abetting
only for SEC; practical consequences.]
Justice Anthony
Kennedy
Makers of statements …
Janus Capital v. First Derivative (US 2011)
Investors
Shareholders
sue
Prospectus
writes
Janus Capital Group
Board of
Trustees
Janus Investment Fund
(Issuer)
Services
(permits
market
timing)
Janus Capital Mgmt
(Investment Adviser)
Rule 10b-5 -- Employment of Manipulative
and Deceptive Devices
It shall be unlawful for any person, directly or
indirectly, by the use of any means or
instrumentality of interstate commerce, or of the
mails or of any facility of any national securities
exchange,
(1) To employ any device, scheme, or artifice to
defraud, (2) To make any untrue statement of a
material fact or to omit to state a material fact
necessary in order to make the statements made, in
the light of the circumstances under which they were
made, not misleading, or (3) To engage in any act,
practice, or course of business which operates or
would operate as a fraud or deceit upon any person
in connection with the purchase or sale of any
security.
Holding:
Is JCM liable for false statements in
Fund prospectus? No
One “makes” a statement by stating it.
… One who prepares or publishes a
statement on behalf of another is not its
maker. [Speechwriter / speaker]
… the maker of a statement is the entity
[ legally independent Fund] with
authority over the content of the
statement and whether and how to
communicate it.
The [SEC’s] definition would permit
private plaintiffs to sue a person who
“provides the false or misleading
information that another person then
puts into the statement.” [drafting same
as engaging in deceptive transactions]
Justice Clarence Thomas
Section 20
(a) Every person who, directly or
indirectly, controls any person
liable under any provision of this
title or of any rule or regulation
thereunder shall also be liable
jointly and severally with and to
the same extent as such
controlled person to any person
to whom such controlled person
is liable, unless the controlling
person acted in good faith and
did not directly or indirectly
induce the act or acts
constituting the violation or
cause of action.
Control person liability …
Lustgraaf v. Behrens (8th Cir 2010)
Section 20
Investors
(a) Every person who,
directly or indirectly,
controls any person liable
under any provision of
this title or of any rule or
regulation thereunder
shall also be liable jointly
and severally with and to
the same extent as such
controlled person to any
person to whom such
controlled person is
liable, unless the
controlling person acted
in good faith and did not
directly or indirectly
induce the act or acts
constituting the violation
or cause of action.
1. Behrens is primary
violator
2. SF “actual control” of
Behrens
3. SF “power over specific
acts” of Behren
Ponzi
scheme
Behrens
Sunset
Financial
Kansas City
Life Insurance
The end
Wright v. Ernst & Young (2d Cir 1998)
Shareholders
Press release
(financials)
reviewed
Ernst & Young
(Auditor)
Executives
BT Office
Products
(Issuer)
assured
Arthur Children’s Trust v. Keim (9th Cir 1993)
Section 20
Investors
(a) Every person who,
directly or indirectly,
controls any person liable
under any provision of
this title or of any rule or
regulation thereunder
shall also be liable jointly
and severally with and to
the same extent as such
controlled person to any
person to whom such
controlled person is
liable, unless the
controlling person acted
in good faith and did not
directly or indirectly
induce the act or acts
constituting the violation
or cause of action.
notes
Joint venture
Keim
• D of Santa Fe
• member Mgmt Comm
• 10% equity owner
• not recruiter
Santa Fe
Company
Parkland
Development
•
•
•
•
"Scheme Liability: A Reply to Grundfest"
McCombs School of Business Research Paper
ROBERT A. PRENTICE, University of Texas at Austin - McCombs School of Business
Email: rprentice@mail.utexas.edu
This paper responds to Professor Joseph Grundfest's recent paper opposing recognition of scheme liability under §10(b)/Rule 10b-5 Scheme Liability: A Question for Congress, Not for the Courts. In responding to Professor Grundfest's cogent arguments, this article tries
to simplify the issue. Section 10(b) is indisputably valid, and it broadly authorizes the SEC to issue rules to protect the investing public
from fraud. The Commission issued Rule 10b-5, using Congress's own words from the antifraud provisions of the 1933 Act, including the
scheme to defraud language. No one suggests that Rule 10b-5 is invalid, so that should largely end the debate. A valid agency rule that
Congress authorized expressly outlaws schemes to defraud in the sale of securities. Q.E.D.
It may be telling that Professor Grundfest's paper neither quotes §10(b) (or Rule 10b-5) nor sets forth the facts of the case. As other
opponents of scheme liability, Professor Grundfest tries to divert attention from the wording of the statute and rule to the holding in Central
Bank. However, Central Bank did not address scheme liability or the proper scope of primary liability under §10(b). It held only that there
is no express cause of action for aiding and abetting liability, with the Court stressing the absence of aiding and abetting language in
§10(b)/Rule 10b-5. However, the necessary language for scheme liability is present in §10(b)/Rule 10b-5.
The Supreme Court has properly noted that divining what Congress would have intended in 1934 often requires historical reconstruction.
Such a reconstruction clearly demonstrates that Congress in 1934 would have expected joint tort liability to be visited upon those who
knowingly participated in a fraudulent scheme to sell securities.
The scheme liability language of Rule 10b-5 was borrowed from Congress's own words in §17(a) of the '33 Act which, in turn, were
derived from the federal mail fraud statute. Case law under both that statute and the common law of fraud (to which the Supreme Court
has also looked for guidance in interpreting §10(b)) indicate that in 1934: (a) all who knowingly participated in fraudulent schemes were
held liable (with no distinction being made between primary and secondary liability), and (b) liability was consistently imposed in cases
that are nearly identical factually (A knowingly participates in B's fraudulent scheme by entering into a fake transaction that enables B to
defraud C) to recent scheme liability cases, including the Stoneridge case currently before the Supreme Court.
Much of Professor Grundfest's article is, in stark contradiction to his title, composed of policy arguments that should be largely irrelevant
to the Supreme Court's determination of Stoneridge. These policy arguments apply equally to the misrepresentation and manipulation
provisions of §10(b)/Rule 10b-5, which are indisputably valid.