Thirteen years after its seminal decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., the United States Supreme Court has announced its intention to speak on the question of secondary actor liability under the federal securities laws. In Central Bank, the Supreme Court held that there can be no private cause of action for aiding and abetting another party’s violation of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. Instead, only primary liability – where each element of a claim is satisfied for each defendant – may exist under Section 10(b).

On March 26, 2007, the Supreme Court granted a petition for writ of certiorari to review the Eighth Circuit’s decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. and Motorola, Inc. Specifically, the Supreme Court will decide whether claims of alleged participation in a fraudulent scheme by a non-speaking defendant can state a claim for primary liability or whether such claims are prohibited aiding and abetting liability. Under the facts on appeal, the defendants at issue made no statements to the supposedly injured shareholders but, instead, are accused of providing assistance to other actors who owed a duty of disclosure to these shareholders and who actually made the supposedly false or misleading statements.

Overview of Rule 10b-5 Liability and Central Bank

Section 10(b) prohibits the use of any “manipulative or deceptive device” in connection with the purchase or sale of any security. Rule 10b-5, promulgated by the SEC pursuant to Section 10(b), contains three subparts describing forms of this prohibited conduct. Rule 10b-5(b) prohibits a speaker from making a false or misleading statement or omission. Rule 10b-5(a) and (c) make it unlawful “to employ any device, scheme, or artifice to defraud[,]” or to engage in “any act, practice, or course of business which operates or would operate as a fraud or deceit[,]” in connection with the purchase or sale of a security.

In Central Bank, the Supreme Court was asked to consider claims against the Central Bank of Denver, an indenture trustee for certain bonds issued by a municipal building authority. The building authority had previously submitted an appraisal on the land securing the bonds. The bank allegedly agreed to delay an independent review of this prior appraisal, despite indications that the first appraisal may have been unduly optimistic. When the building authority defaulted on the bonds, purchasers of the bonds sued various parties for primary liability under Section 10(b) and the Central Bank of Denver for secondary liability for aiding and abetting the alleged fraud. Under these facts, the Supreme Court held that “a private plaintiff may not maintain an aiding and abetting suit under § 10(b),” but any secondary actor defendant such as a lawyer, bank, or accountant “who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met.”

Summary of the Stoneridge Case

In April 2006, the Eighth Circuit issued its decision in Stoneridge, holding that allegations under subparts (a) and (c) of purported participation in a fraudulent scheme were, in reality, an attempt to reinstitute aiding and abetting claims under Section 10(b) and, therefore, were barred by Central Bank. Specifically, the court held that two equipment suppliers, one of which was represented by Alston & Bird LLP, could not be liable to a customer’s shareholders for business transactions that the customer failed to record properly in its financial statements.

It was undisputed that the suppliers had accounted for the transactions properly on their own books, did not make any statements to the customer’s shareholders, had no duty to speak to those shareholders and did not have any control over or input into the customer’s accounting decisions or related financial disclosures. Given the absence of any statements from the suppliers, the plaintiffs chose to pursue claims under subparts (a) and (c) of Rule 10b-5 instead of subpart (b), which speaks in terms of the defendant actually making a misstatement or omission. The plaintiffs argued that the suppliers knew the customer intended to engage in improper accounting and they were, therefore, participants in a “scheme” to assist the customer in defrauding its shareholders. The plaintiffs also argued that Central Bank’s prohibition against aiding and abetting claims dealt only with subpart (b) of Rule 10b-5 and not with conduct-based claims under subparts (a) and (c).

The Eighth Circuit rejected the plaintiffs’ narrow interpretation of Central Bank. The court of appeals held that the terms “deceptive” and “manipulative” as used in Section 10(b) have been given specific meaning by the Supreme Court in Central Bank and other decisions. Deceptive conduct has been interpreted to involve either an affirmative misstatement, or a failure to disclose by one who had a duty to disclose, neither of which was present in the allegations before the court. Manipulative conduct has been interpreted as a “‘term of art’ [referring] to illegal trading practices such as ‘wash sales, matched orders, or rigged prices, that are intended to mislead investors by artificially affecting market activity.’” The Eighth Circuit thus concluded that “any defendant who does not make or affirmatively cause to be made a fraudulent misstatement or omission, or who does not directly engage in manipulative securities trading practices, is at most guilty of aiding and abetting and cannot be held liable under [Section] 10(b) or any subpart of Rule 10b-5.” Accordingly, it held that the district court correctly dismissed the complaint as failing to state a claim as a matter of law.

The Eighth Circuit’s opinion is one of three appellate court decisions on this precise issue. The Ninth Circuit issued an opinion after Stoneridge that took a different view, largely based on existing Ninth Circuit precedent. That case – Simpson v. AOL Time Warner Inc. – is subject to a pending certiorari petition. The Fifth Circuit also recently issued an opinion expressly adopting the Eighth Circuit’s view in Stoneridge. It held that certain banks that did business with Enron prior to its collapse could not be liable under a scheme liability theory because these claims were, in reality, for aiding and abetting Enron’s fraud, not for primary liability, and, thus, were barred by Central Bank.

The resolution of the Stoneridge appeal by the Supreme Court will have a significant impact on the current securities fraud liability climate. Claims of scheme liability under subparts (a) and (c) of Rule 10b-5 have been brought by plaintiffs with increasing frequency following a series of district court decisions in Enron, which gave fuel to this theory. The recent decision by the Fifth Circuit, which rejected the scheme theory from Enron, now presents a significant obstacle for plaintiffs seeking to prosecute such claims. Moreover, Stoneridge presents the Supreme Court with the opportunity to reinforce the basic principles of Central Bank and thereby promote greater certainty concerning the line between actionable primary liability and prohibited aiding and abetting claims.