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Scheme Liability Lives!

By Alexandra Brown | Jul. 2, 2008
News

Law Office Management

Jul. 2, 2008

Scheme Liability Lives!

Plaintiffs attorneys adjust their briefs after the Supreme Court's Stoneridge decision on scheme liability.


     
Interpretations of case law-like history-are often written by the victors. Take, for example, the assessment of so-called scheme liability following the Supreme Court's January ruling in Stoneridge Investment Partners v. Scientific-Atlanta (128 S. Ct. 761 (2008)). At issue were claims pursued under section 10(b) of the Securities Exchange Act and subsections (a) and (c) of SEC rule 10b-5 making it unlawful "to employ any device, scheme, or artifice to defraud," and "to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security."
      The Court's 53 ruling that respondents were beyond the reach of petitioners wasn't exactly a surprise. Justice Anthony Kennedy's majority opinion-much of it relying on his own opinion in Central Bank of Denver v. First Interstate Bank of Denver (511 U.S. 164 (1994))-held that the section's "implied private right of action does not extend to aiders and abettors." Kennedy also warned that "we would undermine Congress's determination [in section 104 of the Private Securities Litigation Reform Act of 1995] that this class of defendants should be pursued by the SEC and not by private litigants."
      The Stoneridge decision was the culmination of a political contest extending from academia to business associations, Congress, the SEC, and the Bush administration. In January, Robert A. Prentice, a professor of business at the University of Texas at Austin, asked in an academic paper, "Why should plaintiffs be able to sue under subsection (b) of rule 10b-5, but not subsection (a)?" Joseph A. Grundfest, professor of law and business at Stanford Law School, responded with his own broadside. "Contrary to Professor Prentice's unsubstantiated assertions, the private right of action under Section 10(b) remains implied. It is not and has never been express. Congress in 1934 did not intend to create a private right of action under Section 10(b), much less one that would encompass scheme liability."
      The academic debate carried over in some 30 amicus briefs filed by former SEC commissioners, members of Congress, some of the nation's largest pension funds, dozens of state attorneys general, and a who's who of law and finance professors, including Grundfest. Rather than present the SEC's position favoring petitioners, the solicitor general bowed to the White House and filed a brief for respondents instead.
      Kennedy's opinion reflected the intense political pressures. Citing the potential for "uncertainty and disruption" should plaintiffs with weak claims be permitted "to extort settlements from innocent companies," he quoted fears he had first expressed in Central Bank that "contracting parties might find it necessary to protect against these threats, raising the costs of doing business." Kennedy continued, "Overseas firms with no other exposure to our securities laws could be deterred from doing business here. This, in turn, may raise the cost of being a publicly traded company under our law and shift securities offerings away from domestic capital markets."
      Legal bloggers had a field day with that passage. "For the love of all things good and holy, why would Kennedy include that kind of needless hyperbolic dicta in an opinion that is already anti-investor?" asked Elizabeth Nowicki, associate professor at Tulane University Law School. "I will bet you $12 that that line becomes one of the most quoted Stoneridge lines within the next two years." Even Larry E. Ribstein, a professor at the University of Illinois College of Law and a signatory to a respondent's amicus brief, wrote in his blog, "Unfortunately, the court seems to have gotten its conclusion from politics rather than jurisprudence."
      Still, the bottom line wasn't good news for proponents of a private right of action in securities class actions. Grundfest told BusinessWeek, "This is 'toes up' for private plaintiffs in these kinds of cases. They are just trying to salvage what they can out of a litigation Waterloo."
      But the plaintiffs bar responded by simply revising its pleadings to exploit language in the opinion. That includes ambiguity both in the definition of primary and secondary actors, and in what constitutes reliance on a defendant's deceptive acts.
      In late March, a federal court in New Jersey denied three motions to dismiss a securities fraud case brought against a defunct generic drug manufacturer (In re Able Labs, 2008 U.S. Dist. LEXIS 23538). Citing Stoneridge, U.S. Judge Joseph A. Greenaway Jr. wrote, "In fact, the Supreme Court recently observed that the suggestion that "there must be a specific oral or written statement before there could be liability under section 10(b) or rule 10b-5 ... would be erroneous since conduct itself can be deceptive."
      "This is the only case since Stoneridge I'm aware of where a court has denied a motion to dismiss," says Thomas A. Dubbs, senior partner at the New York office of Labaton Sucharow and counsel to plaintiffs in Able Labs. "It's still an open question as to the manner in which a scheme must be disclosed, and how reliance by the investor must be met. We believe there is sufficient room in a number of cases to urge scheme liability."
      Plaintiffs attorneys also continue to pursue scheme-liability claims in the Southern District of New York. "Currently we have two cases with scheme-liability claims that are fully briefed and awaiting judgment on motions to dismiss," says Salvatore J. Graziano, a partner in the New York office of Bernstein Litowitz Berger & Grossmann. One of those cases involves securities fraud claims against Mayer Brown and one of its partners (In re Refco, Inc. Securities Litigation, No. 05 Civ. 8626 (S.D.N.Y.)). "Subsequent to our filing suit, defendants in both cases were indicted on criminal charges by federal prosecutors," Graziano says.
      In California, Steven N. Williams, a partner in the Burlingame office of Cotchett, Pitre & McCarthy, says his firm intends to oppose yet another motion to dismiss the Homestore litigation, a leading scheme-liability case recently remanded back from the Ninth Circuit (Simpson v. AOL Time Warner Inc., 452 F. 3d 1040 (9th Cir. 2006)). In late March, Coughlin Stoia Rudman Geller & Robbins filed a supplemental opposition to pending motions for summary judgment in the consolidated Enron cases "that fits squarely within the framework established by the Supreme Court and Fifth Circuit decisions," according to the brief. (In re Enron Corp. Sec. Litig., No. H-01-3624 (S.D. Tex.).)
      The next court test of scheme liability may arise from alleged misrepresentation in the sale of securitized debt obligations and mortgage-backed securities. Earlier this year Navigant Consulting reported that subprime-related securities-fraud class actions accounted for 54 percent of all securities cases filed in 2007. Of those, 87 percent alleged manipulative and deceptive devices and contrivances under section 10(b) and SEC rule 10b-5.
      Stanford's Grundfest says, "I expect the plaintiffs bar will push back on the interpretation of reliance, which, in the language of the Court's opinion, often has references reminiscent of the concept of proximate causation."
      Graziano likes his chances. "Defendants want liability for securities fraud to be like an on-off switch," he says. "But there is no bright line between primary and secondary actors. What should control is behavior-and Justice Kennedy held definitively in Stoneridge that behavior could lead to liability."
     
     
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Alexandra Brown

Daily Journal Staff Writer

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