According to Joseph K. Brenner, Chief Counsel for the Division of Enforcement of the Securities and Exchange Commission (“SEC”), the SEC is currently considering whether actions brought under Section 20(b) of the Securities Exchange Act of 1934 (“Exchange Act”) avoid restrictions imposed by the Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011).1 As Mr. Brenner acknowledged, however, Section 20(b) is relatively unknown, and it has been decades since the SEC last attempted to use the statute to prosecute securities fraud. Given the limited and unsettled jurisprudence surrounding Section 20(b), the SEC may face some interesting legal challenges.
Janus Did Not Address Liability Under Section 20(b)
The Supreme Court held in Janus that only the maker of a statement may be liable for a fraudulent statement under Section 10(b) of the Exchange Act and that a maker is the person or entity with “ultimate authority” over that statement, including its contents and whether and how to communicate it. Hence, only the person with “ultimate authority” can incur liability for making a fraudulent statement. Others who contributed or otherwise caused the fraud to occur potentially may escape liability if they lack “ultimate authority.” AlthoughJanus addressed actions brought by private litigants under Section 10(b) of the Exchange Act, a minority of courts has extended the ruling even to actions brought by the SEC under Section 17(a) of the Securities Act of 1933.
Janus left open the possibility of liability under Section 20(b). Writing for the majority, Justice Thomas stated in a footnote, “we do not address whether Congress created liability for entities that act through innocent intermediaries under [Section 20(b)].” In dissent, Justice Breyer responded, “[i]f the majority believes, as its footnote hints, that [Section] 20(b) could provide a basis for liability in this case...then it should remand the case for possible amendment of the complaint.”
This colloquy suggests that Section 20(b) could potentially supply the basis for liability found lacking in Janus. Mr. Brenner’s remarks that he was “fairly confident and hopeful” that the upcoming year would bring new life to this “powerful statute” indicate that the SEC may soon test this approach.
The Contours of Liability Under Section 20(b) Are as Yet Undeveloped
Section 20(b) of the Exchange Act makes it unlawful for a person directly or indirectly to do anything “through or by means of any other person” which would be unlawful for such person to do under the securities laws and regulations. Like its more well-known counterpart Section 20(a), Section 20(b) addresses situations in which the defendant does not directly commit any securities violations. Section 20(a), however, is a form of secondary liability that requires that the defendant at least have “control” over another person who does directly commit securities violations. In contrast, Mr. Brenner suggests that Section 20(b) may provide for primary liability that does not “require proof of an underlying violation by somebody else.”
Despite the potentially broad scope of Section 20(b), there has been surprisingly little interpretive guidance on the statute since it was enacted in 1934. Prior to Janus, the SEC and private litigants relied on Section 10(b) to establish primary liability for persons who broadly contributed to the securities violation and Section 20(a) to establish secondary liability for those who controlled the violators. After Janus, however, persons who contribute to fraudulent misstatements (e.g., falsifying internal reports) may no longer be liable if they did not “make” the ultimate statements to investors (e.g., issuing the company press release). On the other hand, those who “make” the statements may not be liable if they did not have the requisitescienter with respect to the underlying fraud. Moreover, absent a primary violation, no one could have secondary liability. Section 20(b) could thus potentially provide an alternative basis for the SEC to pursue persons who contribute to the fraudulent statements of others as primarily liable for violating the securities laws “through or by means of another person.”
Existing case law presents some obstacles to establishing primary liability under Section 20(b). District courts have dismissed claims under Section 20(b) where no primary violation has been sufficiently pleaded.2 Another district court has stated in dictum that “[b]oth Sections 20(a) and 20(b) create secondary liability.”3 Other courts appear to conflate Sections 20(a) and 20(b).4 Indeed, only a few courts have attempted to distinguish the two statutes.5
Even if Section 20(b) provides for primary liability, no court has yet fully defined the scope of any such liability. The limited case law to date does not offer strong support for Mr. Brenner’s apparently expansive view on the scope of potential liability. The Sixth Circuit’s decision in SEC v Coffey, for example, suggests that Section 20(b) requires that a defendant have “control” over the other person and “knowing” use of that control to perpetrate the securities violation.6 Mr. Brenner may take some comfort from the Eighth Circuit’s reference in Myzel v. Fields to “the plain meaning of Section 20(b), that one cannot do indirectly through another what he cannot do himself.”7 The Eighth Circuit did not however elaborate on what it means to commit a securities violation “through” another person under Section 20(b), as that issue was not before it. Going forward, the courts, the SEC and other litigants will thus have to grapple with the existence and the extent of primary liability under Section 20(b).