Liability in Securities Fraud Damage Actions and The Supreme Court (Part I)

Three key decisions by the Supreme Court are promising to redraw the contours of liability under the antifraud provisions of the federal securities law by defining three key elements of a private action for damages under Exchange Act Section 10(b) and Rule 10b-5.  One of those decisions was handed down two years ago, one will be issued by the end of the current term and one will be decided next term.

Today we will begin an occasional series reviewing the three cases:  (1) Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), decided two years, focused on loss causation;  (2) Tellabs, Inc. v. Makor Issues & Rights Ltd., No. 06-484 (S.Ct. 2006) which will be handed down this term and will define the requirements for pleading scienter; and (3) Stoneridge Investment Partners, LLC v. Scientific-Atlantic, Inc., No. 06-43 (S.Ct.) which will be decided next term and will define who is liable (i.e., what acts constitutes a primary violation of the securities laws).  Collectively, these decisions may well redraw the contours of liability in securities damage actions.

We will begin with Stoneridge because it focus on the scope of Section 10(b) liability and promises to be the most significant of the three.  The key question to be resolved there is who can be held liable in private securities fraud actions.  In practical terms every corporate director and officer, outside auditor and lawyer, as well as third-party vendors will be watching to see where the Court draws the line in deciding what must be pled and later proven to establish a primary violation.  Those inside the line drawn by the Court can potentially be named as defendants in securities class actions.  Those outside the line will not face potential actions which the Court has repeatedly referred to as burdensome and vexatious.  The decision in Stoneridge may be significantly impacted by whether the Court decides to hear the appeal in the Enron litigation from the Fifth Circuit Court of Appeals.  Regents of the Univ. of Calif. v. Credit Suisse First Boston (USA), Inc., 482 F. 3d 372 (5th Cir. 2007), pet. for cert. filed sub. nom, Regents of the Univ. of Calif. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., No. 06-1341 (S.Ct. April 5, 2007).

In discussing the potential decision in Stoneridge, we will begin with a review of the Court’s decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994), which decided that Section 10(b) does not cover aiding and abetting liability.  In subsequent installments of the series, we will discuss the struggle among the Circuit Courts to fashion a test of primary vs. secondary liability.  First, was the 9th Circuit’s “substantial participation” test.  That was followed by the so-called “bright line test first articulated by the 10th Circuit and later adopted by the second and other circuits.  Finally, there is the 9th Circuit’s version of the SEC’s “scheme liability” test.  We will conclude this segment of the series with a discussion of the key points before the Supreme Court in Stoneridge including the tension between the “catch-all” antifraud provision, and the Court’s search for a clear test for business organizations.  In subsequent installments of the series will review Tellabs and the impact of Dura.  We will conclude by looking at the collective impact of the decisions.