LIABILITY IN SECURITIES FRAUD DAMAGE ACTIONS AND THE SUPREME COURT: Part II – The Roots of Stoneridge.
The issue the Supreme Court will decide in Stoneridge traces its roots back to at least 1994, when the Supreme Court decided Central Bank of Denver v. First Interstate, 511 U.S. 164 (1994). In that case, the Court concluded that there was no aiding and abetting liability under Section 10(b). Stated differently, the Court held that only “primary” violators could be held liable under the Section.
The question of who is a primary violator was left for resolution on another day. Nevertheless, Central Bank suggests much about how Stoneridge will be decided. The holding in Central Bank was a surprise to many. While the Court suggested that its decision was made to resolve a split in the Circuits, this was hardly the case. Prior to Central Bank, aiding and abetting liability under Section 10(b) was well established in both SEC enforcement actions and private damage cases. Every Circuit had acknowledged that there was liability for aiding and abetting. Interestingly, when previously faced with the universal conclusion of the Circuit Courts that there was an implied cause of action under Section 10(b), the Court had acquiesced, despite its own jurisprudence which, beginning at least with Cort v. Ash, 422 U.S. 66 (1975), had consistently constricted implied causes of action. The Central Bank majority, however, ignored this point, as Justice Stevens noted in dissent. The real predicate for the Court’s decision in Central Bank was its efforts to reign in what had been called the “judicial oak” of a court-created implied cause of action, coupled with its concern over the pernicious effects of private securities litigation on business. In a series of decisions such as Santa Fe v. Green, 430 U.S. 462 (1977), Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), and others, the Court had consistently narrowed the scope of Section 10(b), interpreting the literal language of the statute in a constrictive manner. This trend was driven in part by the Court’s oft-stated view that litigation under Section 10(b) is disruptive and extremely vexatious. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975) (“litigation under Rule 10b-5 presents a danger of vexatiosness different in degree and in kind from that which accompanies litigation in general”).
After citing its prior decisions and reiterating the negative impact of Section 10(b) litigation, the Court concluded that “[w]e reach the uncontroversial conclusion, accepted even by those courts recognizing a Section 10(b) aiding and abetting cause of action, that the text of the 1934 Act does not itself reach those who aid and abet …” In reaching this decision, the Court relied almost exclusively on the statutory text, emphasizing the fact that the Section only imposes civil liability on those who “commit a manipulative or deceptive act …” In addition, aiding and abetting liability, the Court noted, is a broad concept and does not provide the “certainty and predictability” necessary for business to know precisely what is precluded by the statute.
While delimiting the scope of the Section, the Court suggested that concept of “primary violators” may be a broader concept than first appears noting: “Any person … including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement … on which a purchaser or seller relies may be liable as a primary violator … assuming all … ” the elements of a cause of action are established (emphasis original).
This statement, along with the focus on deception, reliance and the necessity for certainty as to where the primary/secondary violator line falls, are the keys to the subsequent struggle in the circuit courts to define primary liability and perhaps ultimately to the decision next term by the Supreme Court in Stoneridge. Next: Congress amends the Exchange Act and the Circuit Courts struggle to draw the line between primary and secondary liability.