A second test for determining who is a primary violator began with a decision of the Tenth Circuit Court of Appeals and evolved through subsequent decisions by the Second, Fifth and Eleventh Circuits. In its 1996 decision in Anixter v. Home-Stake Prod. Co., 77 F.3d 1215 (10th Cir. 1996), the Tenth Circuit rejected the holding of In re Software Toolworks, Inc., 50 F.3d 615 (9th Cir. 1994) as mere aiding and abetting.  The case involved a securities law suit against an auditor who had issued false opinions regarding a failed ponzi scheme.  After reviewing the allegations, the Court noted that “the critical element separating primary from aiding and abetting … [is] a representation … by the defendant, that is relied upon … .”  The speaker – here, the auditor – need not communicate the statement himself.  It is sufficient, the Court stated, if the auditor knew or should have know that the representation would be communicated to shareholders.  The Court noted that this test provides more guidance than the “substantial participation” or other similar tests.  

The next year the Second Circuit decided the first of two cases following the Anixter approach.  First, in Shapiro v. Cantor, 123 F.3d 717 (2nd Cir. 1997), the Court reviewed the sufficiency of securities fraud claims against the auditors of a failed video chain.  Plaintiffs contended that the auditors failed to disclose a prior felony conviction of the chain owner and that financial projections prepared by the firm were circulated in offering memos.  The Court rejected the claims as insufficient.  As to the conviction, the Court held that the auditors had no duty to disclose.  As to the financial projections, the court noted that preparing such materials is “consistent with the role of an accountant.”  

Second, in Wright v. Ernst & Young, 152 F.3d 169 (2nd Cir. 1998), the Court followed Anixter in rejecting Software Toolworks, while noting that in Shapiro it had followed what now known as the “bright line” test.  Here, the Court rejected claims that an auditor orally approved release of financial data and results included in a press release which stated that the data was not audited.  The Court held that “if Central Bank is to have any real meaning, a defendant must actually make a false or misleading statement … .”  In a second key portion of its opinion, the Court held that “[a] secondary actor cannot incur primary liability … for a statement not attributed to that actor at the time of its dissemination.”  

The Eleventh Circuit followed the same approach in Ziemba v. Cascade Int’l. Inc., 256 F.3d 1194 (2001).  There, the complaint alleged securities fraud claims against a company and its auditors and law firm.  The law firm, the complaint claimed, participated in drafting false letters and press releases later issued by the company.  The auditors were alleged to have given incorrect advice on consolidating subsidiaries of the company and failed to have issued a “going concern” limitation as to a sub.  The Court rejected the claims and, after reviewing the split in the Circuits, elected to follow Wright.  A “misstatement or omission upon which a plaintiff relied must have been publicly attributed to the defendant” at the time of the investment decision, the court held.  Here, the law firm did not make a misstatement because it had no duty to speak.  The auditors did not make a misstatement because no opinion was ever disseminated to investors. 

Finally, the Fifth Circuit also adopted this position in the Enron litigation, Regents of the Univ. of Cal. v. Credit Suisse First Bank (USA), Inc., 482 F.3d 372 (5th Cir. 2007).  A petition for certiorari is pending in this case.  Thus, the case may be heard with Stoneridge. 

In Credit Suisse a securities fraud complaint was brought against a group of banks who were claimed to have assisted Enron in falsifying its financial statements.  Essentially, the banks entered into business arrangements that permitted Enron to either improperly book revenue or keep liabilities off its books according to plaintiffs.  The complaint claims that each bank knew Enron was engaged in long-term financial fraud.  

The District Court adopted a position on scheme liability advocated by the SEC and refused to dismiss the complaint.  Subsequently the District Court certified the class. 

The Circuit Court, reviewing the case on an appeal of the certification ruling, reversed.  The Fifth Circuit held that the banks had not made a misrepresentation because they had no duty to Enron’s shareholders to disclose.  While Enron committed fraud the banks were, at most, aiders and abettors.  The Court went on to note that it is inappropriate to impose liability for securities fraud on one party to a business deal.  

Next:  Scheme liability 

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The SEC, DOJ and other regulatory authorities are conducting an increasing number of parallel investigations.  While those proceedings offer potential efficiencies for both the government and persons involved, they also offer potential downfalls, as yesterday’s decision by the SEC demonstrates. In In the Matter of Warren E. Turk, Admin. Proc. File No. 3-12404, the SEC remanded a disciplinary proceeding with respect to Mr. Turk to the New York Stock Exchange (“NYSE”) for further consideration.  

The NYSE disciplinary proceeding was brought against Mr. Turk, a former member of the Exchange and a specialist, because he invoked his constitutional right not to testify in an investigation being conducted by the NYSE Division of Enforcement.  The NYSE censured and permanently barred Mr. Turk for failing to testify.  

Mr. Turk claimed, however, that the action of the Exchange was precluded by the Fifth Amendment.  While constitutional limitations only apply to the government and typically and not to self-regulatory organizations (“SROs”), that is not always the case.  Under certain circumstances where the action of the SRO becomes intertwined with that of the government, the SRO may effectively be engaging in state action.  At the time Mr. Turk declined to testify, there was a parallel criminal investigation into certain practices by NYSE specialists.  While Mr. Turk was not charged criminally, he was named as a defendant in an SEC enforcement action.  

While the SEC expressed doubt about the validity of Mr. Turk’s claim, and noted that he bore a heavy burden of proof, it remanded the case to the Exchange for further development of the record.  In doing so, the Commission noted that Mr. Turk had not had the benefit of the decisions in Quatrone, 87 SEC Docket at 2166 and Ficken, 89 SEC Docket at 696, at the time he asserted his claim.  Those cases involved similar claims which resulted in remands for the development of the evidentiary record.  

While it is not clear whether Mr. Turk will prevail after remand, the case is just another reminder of the complexities of parallel proceedings.  The question of intertwined government action is also pending before the Ninth Circuit Court of Appeals, as we have reported earlier in U.S. v. Stringer (post of Nov. 2, 2006).  In that case, a criminal indictment was dismissed where the District Court concluded that the U.S. Attorney’s office effectively concealed the existence of its inquiry behind that of the SEC, thus deceiving the defendants.  With the continuing increase in parallel proceedings, no doubt these and similar issues will continue to develop. 


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