Amicus Curiae Brief — Stoneridge Inv. Partners v. Scientific-Atl.

FILED

AUG 15 2007

Supreme Court of the Hn ag OF THE at

STONERIDGE INVESTMENT PARTNERS, LLC,

Petitioner,

—

SCIENTIFIC-ATLANTA, INC. and MOTOROLA, INC.,

Respondents.

ON WRIT OF CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE EIGHTH CIRCUIT

BRIEF OF THE AMERICAN BANKERS ASSOCIATION,

THE ABA SECURITIES ASSOCIATION,

THE CLEARING HOUSE ASSOCIATION L.L.C.

AND THE FINANCIAL SERVICES ROUNDTABLE

AS AMICI CURIAE IN SUPPORT OF RESPONDENTS

H. RODGIN COHEN*

DAVID H. BRAFF

ROBERT J. GIUFFRA, JR.

MARC DE LEEUW

JEFFREY T. SCOTT

STEVEN J. PURCELL

SULLIVAN & CROMWELL LLP

125 Broad Street

New York, New York 10004

(212) 558-4000

Counsel for Amici Curiae

American Bankers Association,

The ABA Securities Association,

The Clearing House Association L.L.C.

and The Financial Services Roundtable

August 15, 2007 *Counsel of Record

TABLE OF CONTENTS

Page

STATEMENT OF INTEREST OF AMICI] CURIAE........... |

EE GE IIE PUI csciekcccncdccssscededscdncscecccisesacutos 3

bg et 8 | a 4

I a 6

I. PETITIONER’S “SCHEME” THEORY WOULD

ELIMINATE SEVERAL ESSENTIAL

REQUIREMENTS OF SECTION 10(b) ................ 6

A. Petitioner's “Scheme™ Theory Would

Eliminate the Reliance, “In Connection

With” and Loss Causation Requirements of

I HID raitsinscendihaniticnakiininmindandsiintiinnininictainis 7

B. Petitioner's “Auditor Deception”

Allegations Cannot Cure Its

Legally Flawed “Scheme” Theory ................ 1]

II. IF ADOPTED, PETITIONER'S “SCHEME™

THEORY WOULD ADVERSELY AFFECT

OUR NATION'S FINANCIAL MARKETS......... i4

A. Petitioner's Vague “Purpose and Effect”

Test Cannot Be Rationally Administered and

Would Lead to Arbitrary Results .................. 15

B. Petitioner's “Purpose and Effect” Test

Would Deter Beneficial Economic Activity

by Financial Services Companies.................. 17

Il. THE COMMON LAW DOES NOT SUPPORT

PETITIONER'S “SCHEME” THEORY .............. Re

A. The Common Law Has No Beuring on the

Interpretation of Section LOD)... 22

B. “Scheme~ Claims Would Amount to

No More Than Aiding and Abetting or

Conspiracy Claims at Common Law.............

1. Common Law Fraud Requires

Reliance by the Plaintiff on the

Defendant's Misrepresentation..............

tl

The Common Law Authorities

Cited by Petitioner's Amici Do

Not Support Its “Scheme” Theory.........

Ss IO sccrtcccincntctciinpsintinsdinniviitiinaseaipnescniitiidaddinnuiidahiaes

os

2s

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30

TABLE OF AUTHORITIES

Page(s)

Cases

Basic Inc. v. Levinson, 485 U.S. 224 (1988)... )

Blue Chip Stamps v. Manor Drug Stores,

A ne 6 ae0ae

Brackeu v. Griswold, 20 N.E. 376 (N.Y. 1889) .0..00.0....... 25

Central Bank of Denver, N.A. v. First Interstate

Bank of Denver, N.A., 511 U.S. 164 (1994)... passim

Chiarella v. United States, 445 U.S. 222 (1980) ........ 13, 30

Crompton v. Beedle, 75 A. 331 (Vt. W910) ooo 26

Dinsmore v. National Hardwood Co..

TE, He IIR, IID vcccéncenconcccascssdcneisbnaceneeseesss 25

District Motor Co. v. Rodill,

png ate RR nO PO 27

Downey v. Finucane, 98 N.E. 391 (NLY. 1912) 20... 26

Dura Pharms.. Inc. v. Broudo, 544 U.S. 336 (2005) ........ 10

Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976)............. 9

Filler v. Hanvit Bank, Nos. O1 Civ. 9510.

02 Civ. 8251, 2003 WL 22110773

Eee }2

Hobbs v. Boatright, 93 S.W. 934 (Mo. 1906) «0.0.2.0... 29

Hindman v. First Nat‘l Bank of Louisville.

ise 2 Ff Lek, eee! Se.

In re Dynegy, Inc. Sec. Litig..

339 F. Supp. 2d 804 (S.D. Tex. 2004) ....................000 10

Judson v. Cook, 11 Barb. 642 (N.Y. Gen. Term 1852)..... 29

Laidlaw vy. Organ, 15 U.S. (2 Wheat.) 178 (1817)............ 26

Lamp}. Pleva, Lipkind, Prupis & Petigrow

v. Gilbertson, SOL U.S. 350 (1991) ..........ccceesserseesee wer

Lawyers Title Ins. Corp. v. United Am. Bank of

Memphis, 2\ F. Supp. 2d 785 (W.D. Tenn. 1998)...... 12

Lindberg Cadillac Co. v. Aron,

371 S.W.2d 651 (Mo. Ct. App. 1963)... eeeeeeeee 27

Marine Bank v. Weaver, 455 U.S. 551 (1982)..................23

Merchants’ Nat'l Bank v. Armstrong,

me eek FE) .) ere -

Noved Realty Corp. v. A.A.P. Co..,

BO PE. As SE RPM, SINE PIPED ccccscnccosnsevensccccesscsvnse 26

Peek v. Gurney. (1873) L.R. 6 HLL. 377 «0.00. 24, 25

Pennebaker v. Kimble, 269 P. 981 (Or. 1928) .................. 26

Pinter v. Dahl, 486 U.S. 622 (1988) ..............cceseeeeeeees 15. 22

Purdum v. Edwards, 141 A. 550 (Md. 1928)..............00. 26

Regents of the Univ. of Cal. v. Credit

Suisse First Boston (USA), Inc..

ed BB N,N Ree ere 8. 23

Salzman v. Maldaver. 24 N.W.2d 161 (Mich. 1946)........ 27

SEC v. Zandford. 535 U.S. 813 (2002) ....... ccc cceeeeeee. 9, 23

Simpson Vv. AOL Time Warner Inc..

BBD FF CI Ge Ch OD inicnccseccscccnnccccnssccies }2-13

Stewart v. Wyoming Cattle-Ranche Co..

I a a starnebnaaniniication 26

Touche Ross & Co. v. Redington.

CL th RF SRD

United States v. O'Hagan, 521) U.S. 642 (1997)..0000..... 9. 30

1\

Virginia Bankshares, Inc. v. Sandberg,

I re IID thin cticieiiciitsitictnntsicinsinsiiniiopiniin 17, 23

Virtue v. Creamery Package Mfg. Co..

OBS FS. We. Tree GIN, CONE vecsvesesvessvensensesssoccteteeneensies 29

Wells Fargo Bank v. Arizona Laborers, Teamsters,

& Cement Masons Local No. 395 Pension

Trust Fund, 38 P.3d 12 (Ariz. 2002) ...............000000000000 |?

White v. Moran, 134 Ill. App. 480 (App. Ct. 1907).......... 29

Statutes and Regulations

BP RAs: FRY ccictcctccericonstistainnisstiuiabaidninalicdia passim

FF eels 1F Piee li cciscnsssaseniscunstninsveeninnaiabghniiadaietahondiadlalae 26

BS ERE oF POD secccncssesinessonssmnenensteonssseenmitininiiaaal 6-7

SD RAE FED. .ccececisssesnevtvinisivinicisinicmestaneinaaal 10

a A I ec.danse aceseuietiaaiateceien coma beer passim

Private Securities Litigation Reform Act of 1995

Pub. L. No. 104-67. 109 Stat. 737 (1995) ........... passim

Other Authorities

141 CONG. REC. $8896 (daily ed. June 22, 1995).......00.... 17

148 CONG. REC. $6584 (daily ed. July 10, 2002) ...0...0....... 7

Janet Cooper Alexander. Do the Merits Matter? A

Study of Settlements in Securities Class Actions,

SP De 6. es Se OEP tiasesdeiicccessnscecscteiadiadeden 16

Briel tor Respondents, Central Bank,

511 U.S. 164 (No, 92-854). 1993 WL 407323...... 22, 29

Brief for the Securities and Exchange Commission as

Amicus Curiae in Support of Respondents,

Central Bank, 511 U.S. 164 (No. 92-854),

an aT cetichecrinsttiecilidenbabantnentindenssocensasocens 29

Brief of Amicus Curiae Trial Lawyers for Public

Justice et al. in Support of Respondents.

Central Bank, 511 U.S. 164 (No. 92-854).

EE 29

John C. Coffee, Jr.. Reforming the Securities Class

Action, 106 COLUM. L. REV. 1534 (2006)........00....0... 20

COMM 'N ON THE REGULATION OF U.S. CAPITAL

MKTS. IN THE 21° CENTURY, REPORT AND

RECOMMENDATIONS (Mar. 2007), available at

http://www.uschamber.cony/publications/reports/

O7O3capmMarketsCOmmM. NeM............0cccccscecerceesseeeseeeees 16

Todd Davenport, The Uneven Evolution of

Accounting Standards, AMERICAN BANKER.

ih lll ert eterideninensenenetasoesnenense 19

Patrick M. Garry et al., The Irrationality of

Shareholder Class Action Lawsuits,

Re 16

| | __._. eETTIE 7

H.R. REP. No. 104-369 (1995). as reprinted in 1995

I EE alata tririrgebtiiindinidegiiiindindinincintnniasenen 17

Int'l Swaps & Derivatives Ass'n. Summaries of

Market Survey Results, http://www. .isda.org/

statistics/recent. html (last visited Aug. 7, 2007) ......... 19

Louts Loss & JOEL SELIGMAN, FUNDAMENTALS OF

SECURITIES REGULATION (Sth ed. 2004) ............... 23. 24

VI

OFFICE OF THE COMPTROLLER OF CURRENCY, OCC’S

REPORT ON BANK DERIVATIVES ACTIVITIES.

FOURTH QUARTER 2006, available at

http://www.occ.treas.gov/tip/deriv/dq406. pdf ............ 19

Oversight of Investment Banks’ Response to the

Lessons of Enron: Hearing Before The Permanent

Subcomm. of Investigations of the S. Comm. on

Governmental Affairs, 107th Cong. (2002)...... 18-19, 20

RICHARD PAINTER ET AL., PRIVATE SECURITIES

LITIGATION REFORM ACT: A POST-ENRON

ANALYSIS (Federalist Soc’y for Law & Pub.

Pol'y Studs. 2002), available at http://www .ted-

soc.org/doclib/20070323_PSLRAFINALIL pdf.......... 16

RESTATEMENT (FIRST) OF TORTS............000000088 26-27, 28, 29

S. Rep. No. 104-98 (1995), as reprinted in 1995

enn as UT WMsicacisiicdciicnthtsetianiniinidibcbaghsididauieeninn 16, 17

S. Rep. No. 109-14 (2005), as reprinted in 2005

IAN Mntadinusidinnccnisuanidincesnitanisnnddcinnineninceneniiatede 16

Harry Shulman, Civil Liability and the Securities Act,

FF in Be GE CD :senstressncneenentneanesennremnnnestion 30

ANJAN V. THAKOR, THE UNINTENDED

CONSEQUENCES OF SECURITIES LITIGATION

(U.S. Chamber Institute for Legal Reform 2005).

avatlable at

http://www.instituteforlegalreform.org/ issues/

i Oe 20-21

vi

STATEMENT OF INTEREST OF AMICI CURIAE'

The American Bankers Association (“ABA”) is the

principal national trade association of the financial services

industry in the United States. Its members, located in each of

the fifty States and the District of Columbia, include financial

institutions of all sizes and types, both federally and state-

chartered. ABA members hold a majority of the domestic

assets of the banking industry in the United States.

The ABA Securities Association (“ABASA”) is a

separately chartered trade association and non-profit affiliate

of the American Bankers Association. ABASA is devoted to

forming and exploring policy that relates to banking

organizations involved in the securities business.

The Clearing House Association L.L.C. (the

“Clearing House”), founded over [50 years ago, is an

association of eleven leading commercial banks that. through

an affiliate, provides payment, clearing and settlement

services to its member banks and other financial institutions.

The Financial Services Roundtable ts a national

association whose membership includes 100 of the largest

integrated financial services companies providing banking,

insurance. and investment products and services to the

American consumer.

The ABA, ABASA., Clearing House and Financial

Services Roundtable (collectively. “Amici”) regularly present

the views of their members on important public policy issues

' Pursuant to Rule 37.6. counsel certifies that this brief was not authored.

in Whole of in part. bs counsel for any parts. and no person or entity other

than Amici. ther members. and their counsel contributed monetarily to

the preparation or submission of the briet. The parties have consented to

the filing of the brief and copies of their letters of consent have been

lodged with the Clerk of the Court.

that impact the financial services industry by, among other

things, appearing as amicus curiae in this Court.

The issue presented here—whether this Court should

create a private cause of action under Section 10(b) of the

Securities Exchange Act of 1934 (“1934 Act”) against banks

und other financial institutions, vendors, law firms and other

third parties that do business with — publicly-traded

companies—is of critical importance to Amici and the

Nation’s economy. The plaintiffs’ bar in securities class

auctions reflexively targets the “deep pockets” of financial

services companies when the issuer or other primary actors,

including the issuer's executives. ure bankrupt or otherwise

judgment-proof. These strike suits reduce the efficiency and

competitive position of the U.S. capital markets.

Petitioner has developed a so-called “scheme” theory

that largely would eviscerate not only this Court's holding in

Central Bank of Denver, N.A. v. First Interstate Bank of

Denver, N.A., 511 U.S. 164 (1994), that Section 10(b) does

not permit a private cause of action for uiding and abetting,

but also Congress's subsequent express refusal to grant such

uuthority to private plaintiffs in the Private Securities

Litigation Reform Act of 1995 (“PSLRA”). If this Court

uccepts Petitioner's open-ended theory. private plaintiffs

could sue all financial institutions that did business with a

public company simply by claiming that the financial

institution was part of the public company’s “scheme to

defraud.”

Under Petitioner's “scheme” theory. the liability of a

financial institution would turn on whether the “purpose and

effect” of a transaction was to portray falsely a company’s

financial condition. Because of the inherently amorphous

nature of Petitioner's proposed legal standard. financial

institutions could fuce potentially ruinous liability based on

their mere participation in routine — financial-markets

transactions whenever a public company is accused of

misrepresentation in respect of that transaction.

5

Moreover, because of the highly subjective nature of

Petitioner's proposed legal standard, financial institutions

would be unable to extricate themselves from meritless class

actions at the motion to dismiss stage. Instead, faced with the

risk that a jury could enter a massive damages award,

financial institutions would be coerced into costly and unfair

settlements. Such a legal regime would, in effect, make

financial institutions insurers for losses suffered by investors

in public companies.

This Court should not rewrite the securities laws. If

adopted, Petitioner's “scheme” theory would negatively

impact the availability of bank financing and risk-mitigation

transactions, deter socially beneficial economic transactions,

impair the proper functioning of this Nation's financial

markets and, ultimately, threaten the safety and soundness of

individual financial institutions and the Nation's banking

system.

STATEMENT OF THE CASE

Plaintiffs filed this class action on behalf of certain

present and former shareholders of Charter Communications,

Inc. (“Charter”), a cable television provider, against Charter

itself and its executives and auditor, us well us Scientific-

Atlanta. Inc. and Motorola. Inc.. two equipment vendors that

had done business with Charter (“Vendors”). Plaintiffs

alleged that Charter defrauded plaintiffs through the issuance

of false and misleading financial statements. Plaintiffs further

alleged that the Vendors were liable as primary violators of

Section 10(b) of the 1934 Act because they participated in a

“scheme to defraud” by engaging in certain “sham” business

transactions with Charter.

Petitioner contends that the Vendors should be liable

for participating in these “sham transactions” because the

Vendors knew that Charter would use those transactions “to

further the scheme to overstate [its] revenue and operating

cash flow in financial statements which were filed with the

SEC and issued to the investing public.” (Pet. Br. 9. 12.)

3

Petitioner further claims that the Vendors “deceived”

Charters auditor about the nature of the transactions by

“backdating” and otherwise falsifying certain transaction

documents. (See id. at 6-9; J.A. 55a-60a (SAC YY 100-10).)

Petitioners do not allege that the Vendors were involved in,

or had any control over, Charters accounting and financial

reporting of the challenged transactions.

The district court dismissed the Section 10(b) claims

brought against the Vendors, finding that their alleged

conduct amounted to aiding and abetting. not a primary

violation of Section 10(b). (Pet. App. 69a.) The Eighth

Circuit affirmed. (/d. at 10a-1 1a.)

SUMMARY OF ARGUMENT

This case directly implicates this Court's decision in

Central Bank, which held that Section 10(b) does not

authorize a private cause of action for aiding and abetting a

securities fraud. Just a year after Central Bank, Congress

enacted the PSLRA and expressly decided not to permit a

private right of action for “aiding and abetting.” while

providing the power to bring such claims to the SEC, the

expert agency responsible for the supervision of our Nation's

securities markets. Because Petitioner's “scheme” theory is

but another form of “aiding and abetting” expressed in

different terminology. Petitioner and its amici effectively ask

this Court to overrule Central Bank and to ignore Congress's

refusal to grant such authority to the plaintiffs” bar in the

PSLRA.

In advancing their “scheme” theory. Petitioner and its

amici argue that the distinction between a primary violation

of Section 10(b) and “aiding and abetting” such a violation ts

nothing more than a legal technicality that should not permit

persons with knowledge of the potential for securities fraud

lo escupe responsibility for their actions. This is wrong.

First. it is Congress's prerogative to decide what

auctions subject a person or entity to civil: liability for

securities fraud under Section l0(b). In the PSLRA.

4

Congress exercised that prerogative and clearly decided that,

ws a matter of national policy, private “aiding and abetting”

claims should not be allowed. In so doing. Congress decided

that the distinction between a primary violation and aiding

und abetting is not a technicality at all, but an important

limitation on the reach of Section 10(b) tin private class

actions.

Second, notwithstanding Petitioner's protestations

that secondary actors would enjoy immunity under the

Eighth Circuit's standard, aiders and abettors of violations of

Section 10(b) are not beyond the reach of the law. In the

PSLRA, Congress specifically authorized the SEC to bring

enforcement actions against aiders and abettors and. if

warranted, to impose large financial penalties and other

forms of punitive relief. In addition, such aiders and abettors

ure subject to federal and state criminal prosecutions and

state civil litigation.

By any measure, Petitioner's “scheme” theory is an

uttempted end-run around Congress's decision not to allow

private aiding-and-abetting claims. —- Fundamentally.

Petitioner's “scheme” theory cannot be reconciled with this

Court's devision in Central Bank that a private plaintiff must

estublish every clement of Section 10(b) against each

defendant to establish a primary violation. In particular. as

applied to the Vendors’ conduct in this case. Petitioner's

“scheme” theory would impose liability improperly on the

Vendors for conduct that was (1) not relied on by Charter’s

investors, (2) not “in connection with” the purchase or sale of

Charters securities, and (3) not the cause of the losses

allegedly suffered by Charter’s investors.

Petitioner's proposed “purpose and effect™ test to

implement its “scheme” theory also would exacerbate the

amount of vexatious securities fraud litigation and thereby

undermine one of the central gouls of the PSLRA. This test

would allow the plaintiffs” bar to cast a broad net. based on a

vague und unclear test. to ensnare “deep pocket” secondary

5

actors such as Amici's members in virtually any securities

case based on a public company’s alleged misstatements. By

contrast. the Eighth Circuit test properly excludes from

Section 10(b) civil liability to private parties based on

conduct amounting to aiding and abetting, and provides clear

guidelines as to what conduct is prohibited.

The claim of certain amici that Petitioner's “scheme”

theory would have supported a fraud claim agains! the

Vendors at common law ts both irrelevant and wrong. As this

Court has long held, the common law is irrelevant when this

Court has already authoritatively construed u federal statute,

particularly when the cause of action has been implied by

courts rather than provided by Congress. In any event. the

Vendors’ conduct here would not constitute fraud at common

law because Charter’s investors did not re/y on that conduct;

such a claim would constitute. at most. aiding and abetting,

which this Court recognized in Central Bank was not

imported into Section 10(b).

ARGUMENT

I. PETITIONER’S “SCHEME” THEORY

WOULD ELIMINATE SEVERAL ESSENTIAL

REQUIREMENTS OF SECTION 10(b).

In Central Bank, this Court rejected aiding-and-

abetting liability under Section 10(b) and squarely held that a

plaintiff must prove every element of a Section 10(b) claim

as to each defendant based on that defendant's own conduct.

Following Central Bank, Congress expressly refused to

authorize private aiding-and-abetting claims. and chose to

permit only an experienced regulator. the SEC. to pursue

such claims. See PSLRA. Pub. L. No. 104-67. § 104. 109

Stat. 737, 757 (1995) (codified us amended at 15 U.S.C.

§ 78t(e)).-

The requirement that a plaintiff establish that each

defendant committed its own primary violation is the critical

limitation on liability under Section 10(b). As this Court

observed in Central Bank, it is the concept of an independent

primary violation of the statute that provides the demarcation

between actionable primary liability under Section 10(b) and

non-actionable aiding and abetting. Simply put, a primary

violation involves more than “knowing and substantial

ussistance” of a fraud: There must be a showing that the

defendant's conduct, standing alone, satisfies each element of

Section 10(b). 511 U.S. at 191.

In contravention of Central Bank, Petitioner's

“scheme” theory would permit private plaintiffs to pursue

uiding-and-abetting claims under a different name. This

Court should not permit private plaintiffs to evade Central

Bank and the PSLRA by labeling conduct part of a “scheme”

when that conduct is nothing more than aiding and abetting.

Petitioner's effort at evasion is confirmed by its inability to

draw a meaningful. much less clear. line between a “scheme”

violation and non-actionable aiding and abetting.

A. Petitioner's “Scheme” Theory Would Eliminate

the Reliance, “In Connection With” and

Loss Causation Requirements of Section 10(b).

By any measure, instead of satisfying the statutory

requirement of an independent primary violation. Petitioner's

theory would permit plaintiffs in securities fraud cuses to

bring a Section 10(b) claim against a bank or other financial

Congress again declined to create a private cause of action tor aiding

and abetting when it passed the Sarbanes-Oxley Act in 2002. despite

requests from some legislators that it do so. See. e.g.. HER. Rep. No. 107-

414. at 54 (2002) (minority views): 148 CONG. R&C. S6584 (daily ed.

July 10. 2002) Gamendment submitted by Sen. Shelby).

institution based on the statements and conduct of other

participants in the alleged scheme. This form of pleading

would eviscerate at least three essential elements of a Section

10(b) claim: (i) reliance: (ii) the “in connection with”

requirement: and (iii) loss causation.

Reliance. A defendant can be liable under Section

10(b) only if. among other things, the defendant “employs a

manipulative device or makes a material misstatement (or

omission) on which a purchaser or seller of securities relies.”

Central Bank. 511 U.S. at 191 (emphasis added); see also id.

at 180 (to prove reliance on a secondary actor, plaintiffs must

show they specifically relied on the “statements or actions”

of that secondary actor). In Central Bank, this Court

emphasized the reliance requirement in rejecting the

plaintiffs’ claim, stressing that “to allow the aiding and

abetting action proposed in this case. the defendant could be

liable without any showing that the plaintiff relied upon the

aider and abettor’s statements or actions.” /d. at 180 (internal

citations omitted). As the Fifth Circuit has observed,

“reliance ... is a specific. defining element of the relevant

legal violation... .” Regents of the Univ. of Cal. v. Credit

Suisse First Boston (USA), Inc., 482 F.3d 372. 385 (Sth Cir.

2007).

Petitioner does not—and cannot—contend _ that

investors in Charters securities relied on the Vendors’

transactions themselves. or anything else the Vendors are

alleged to have done, as opposed to Charter’s disclosures to

investors. For the transactions themselves to have been

deceptive. those transactions would need to be deceptive

regardless of how they were accounted for and reported by

Charter in its financial statements. In fact. after the

transactions were executed, Charter could have reported

those transactions in accordance with applicable accounting

rules and Charter’s other disclosure obligations. Charter’s

failure to comply with these requirements cannot make the

Vendors primary violators of the securities laws.

By arguing for reliance on a primary violator’s

misrepresentation as satisfying the reliance requirement for a

secondary actor's conduct, Petitioner seeks to evade a core

holding of Central Bank. Under Petitioner's theory, an

allegation of “scheme to defraud” would eliminate the need

for reliance. with the effect of permitting aiding-and-abetting

claims as primary violations. This is impermissible. See also

Basic Inc. v. Levinson, 485 U.S. 224, 243 (1988) (proof of

reliance is essential because it “provides the requisite causal

connection” between a defendant's conduct and a plaintiffs

injury).

“In connection with.” Section |0(b)'s “in conn “tion

with” requirement cannot be satisfied unless a defendint’s

allegedly wrongtul activities “coincide” with the purchase or

sale of a security. SEC v. Zandford, 535 U.S. 813, 822, 824-

25 (2002); United States v. O'Hagan, 521 U.S. 642, 656

(1997). The transactions in question here did not—and

indeed could not—coincide”™ with any purchases or sales of

Charter securities. Rather, it was only Charter’s subsequent

public issuance of financial statements allegedly improperly

reflecting the effects of those transactions that could have

misled investors in conpection with securities transactions.

The “in connection with” requirement is not satisfied

by un allegation that the “scheme” ttself—an abstract concept

representing the undifferentiated aggregation of all

defendants’ conduct—coincided with the purchase of

securities. To ensure that aiders and abettors are not held

liable as primary violators, Central Bank requires a showing

that the conduct of each secondary actor independently

satisfies every element of a Section 10(b) claim without

regurd to the conduct of other defendants. 511 U.S. at 191.

This Court should not permit Petitioner to evade the

requirements of a Section 10(b) cause of action by

talismanically invoking the supposedly magic word

“scheme.” which does not appear anywhere on the face of

Section 10¢b). See Central Bank, 511 U.S. at 173: Ernst &

Ernst v. Hochfelder, 425 U.S. 185. 214 (1976). Petitioner's

9

“scheme” theory would effectively read the “in connection

with” requirement out of Section !0(b)."

Loss Causation. \n order to prevail on a claim under

Section 10(b), this Court has held that a plaintiff must also

prove facts showing “loss causation”—-i.e.. the causal

connection between a defendant's allegedly actionable

conduct and plaintiffs damages. Dura Pharms., Inc. v.

Broudo, 544 U.S. 336, 342 (2005) (loss causation element

requires proof that issuer's stock price declined because of

revelation of defendant's statement, omission or act); see

also 15 U.S.C. § 78u-4(b)(4) (“plaintiff shall have the burden

of proving that the act or omission of the defendant . . .

caused the loss for which the plaintiff seeks to recover

damages”) (emphasis added).

Here, the Vendors did not make any actionable

misstatements to investors—indeed. their conduct was

unknown to the market. Accordingly, the Vendors’ conduct.

in contrast to Charter’s allegedly subsequent misstatements,

could not—and did not—in any way affect the market price

for Charter securities. Because no “causal connection”

existed between any decline in Charters stock price and the

Vendors’ conduct, Petitioner cannot demonstrate loss

causation as to the Vendors’ alleged participation in the

The decision in In re Dynegy, Inc. Securities Litigation. 339 F. Supp.

2d 804 (S.D. Tex. 2004). tlusirates a proper application of the “in

connection with” requirement to the sort of “scheme” allegations

Petitioner relies on here. See id. at 916 (plamulls allegations that

Citigroup structured and funded transactions with Dynegy to conceal

from Dynegs’s balance sheet hundreds of millions of dollars in debt and

to inflate Dynegy s reported income and cash flows did not satisty the “on

connection with” requirement “[bJecause plamtifts in this case do not

allege amy facts showing that Crtigroup’s allegedly manipulative and

deceptive acts comeinded with sales of Dynegs securities”) (emphasis

added).

purported scheme to defraud. Thus, Petitioner's “scheme™

theory would read loss causation out of Section 10(b).

* * Sa

This Court's strict adherence to each of the

requirements of a Section 10(b) claim is particularly

important to Amici and their members. Amici's members

provide much of the funding and financial risk mitigation for

thousands of publicly-traded companies, and thereby the

Nation's economy as a whole, through hundreds of thousands

of financial transactions. In many cases, these transactions

inherently raise complex accounting and disclosure issues

within the unique knowledge of the borrower or counterparty

and its accountants. Yet, under Petitioner's open-ended

theory, financial institutions would face the prospect of huge

liability for the improper accounting or public disclosures of

their borrowers and counterparties, without any participation

in that accounting or disclosure.

B. Petitioner’s “Auditor Deception” Allegations

Cannot Cure Its Legally Flawed “Scheme”

Theory.

Petitioner seeks to rely on allegations that the

Vendors’ conduct “deceived” Charter’s auditors. who

purportedly would have stopped Charter from perpetrating a

fraud had the “sham” nature of the transactions been apparent

to them. (See Pet. Br. 40.) These allegations cannot cure the

fundamental flaws in Petitioner's “scheme” theory. because

those allegations do not satisfy the essential elements of the

Section 10(b) claim against the Vendors

In the first place. any alleged “deception” of Charters

auditors by ithe Vendors amounts. at most. to “substantial

assistance” of Charter’s deception of its investors, i.¢., viding

and abetting. It is undisputed that Charter remained tree—~

after the closing of Charter’s transactions with the Vendors—

to make full and accurate disclosure to its auditors and to

account for and report the transactions properly. If Charter

did not do so, it was only Charter and others involved in

Charters accounting and financial reporting that “used or

employed” a deceptive device to deceive investors with

respect to those transactions.”

Section 10(b), as interpreted by the courts, provides a

cause of action for defrauded investors. Allegations of

deception that enable someone else to defraud investors—

such as deception of an issuer's auditors—are not primary

violations of Section 10(b). See. e.g.. Filler v. Hanvit Bank,

Nos. 01 Civ. 9510, 02 Civ. 8251, 2003 WL 22110773, at *1,

*2 (S.D.N.Y. Sept. 12, 2003) (secondary actors’ alleged

“false confirmations” to issuer's auditor that certain loans

made to issuer were non-recourse were not a primary

violation), aff'd, 156 Fed. Appx. 413 (2d Cir. 2005); Lawyers

Title Ins. Corp. v. United Am. Bank of Memphis, 2\ F. Supp.

2d 785, 799-801 (W.D. Tenn. 1998) (conduct of defendant

bank that plaintiffs could not have relied on but which helped

prevent primary violators fraudulent scheme from being

discovered constitutes aiding and abetting): Wells Fargo

Bank v. Arizona Laborers, Teamsters & Cement Masons

Local No. 395 Pension Trust Fund, 38 P.3d 12, 27 (Ariz.

2002) (bank's conduct preventing discovery of primary

violator’s fraudulent scheme constitutes aiding and abetting).

Even the Ninth Circuit in Simpson—on which Petitioner

relies tor its “purpose and effect” test (Pet. Br. 32-33)—

recognized that deception of an auditor—as opposed to

investors—could not form the basis for primary Section

10(b) liability. See Simpson v. AOL Time Warner Inc., 452

F.3d 1040. 1043-44, 1052-53 (9th Cir. 2006).° If the law

4

As Central Bank made clear. Section LOC) prohibits the use and

emploment of a deceptive device. not “giving atid to a person who

commits a manipulative or deceptive act.” S)1 U.S. at 177.

In Sempson. the court rejected allegations that a secondary actor

committed a primary violation by Gd) deliberately structuring transactions

ma manner to keep Homestore’s auditor trom “recogniz[ing| that the

revenue that Homestore recorded was related to a prior transaction tunded

}>

were otherwise, there would be no way to distinguish

primary liability from aiding and abetting.

Petitioner cannot sustain its “scheme” theory by

characterizing the Vendors’ purported “deception” of

Charters auditors—allegedly backdating and otherwise

falsifying certain transaction documents—as “conduct” or a

misrepresentation or an omission. Regardless of labeling.

the Vendors’ actions do not satisfy the elements of a

Section 10(b) claim. First, the statements in these documents

were never made publicly available or otherwise

communicated to investors such that any investor could have

relied on those statements. Second, the alleged deception of

Charter’s auditors occurred contemporaneously with the

transactions and, therefore, such purported deception was not

“in connection with” investors’ subsequent purchases of

Charter’s securities. Third, the allegedly falsified documents

were not disclosed to the market and, thus, could not have

been the cause of any decline in Charter’s stock price and

uny investor losses.

Indeed, Petitioner's theory concerning the Vendors’

purported “deception” of Charter’s auditors serves only to

contirm that the Vendors did not commit a primary violation

of Section 10(b). Petitioner concedes that Charter’s “false

financial statements . . . deceived investors” (Pet. Br. 38)—in

by Homestore.” and (i) agreemg to conceal information regarding the

cuwecular nature of the transactions by documenting transactions in such a

way as to “not alert [the auditor! to the nature of the round-trip

transaction.” 452 F.3d at 1043-44.

In fact. the Vendors dealt only with Charter and had aw dealings with

Charters auditors. with whom Charter dealt on Hs own. In any event. the

Vendors owed Charter’s auditors no duty to disclose information and.

thus. the Vendors” purported nondisclosure of information to Charter’s

auditors cannet. as a matter of law. form the basis for primary liabelity.

See. ¢... Chiarella \. United States, 445 U.S. 222. 235 (1980).

13

other words, that it was plaintiffs’ reliance on Charter’s

statements that caused the alleged losses Petitioner seeks to

recover in this case. Nonetheless, Petitioner claims that the

Vendors are liable under a multi-step “buil[d] upon” theory,

i.¢., the financial statements were “built upon” the deception

of “Charter’s auditors[, who] never would have acquiesced to

the publication of those [financial statements|” had the

auditors not been “deceived” by the Vendors’ conduct. (/d. at

38. 40.) In maintaining that Charter’s alleged fraud was

“built upon” the Vendors’ actions. Petitioner effectively

concedes that the Vendors’ actions. at most, aided and

abetted Charter’s primary violation and did not themselves

constitute a primary violation.

Il. IF ADOPTED, PETITIONER’S “SCHEME”

THEORY WOULD ADVERSELY AFFECT OUR

NATION'S FINANCIAL MARKETS.

This Court should not create an amorphous and

subjective theory of potentially catastrophic liability that

would impede the important functions of banks and other

financial institutions im providing the financial fuel that

drives our Nation's economy. By any measure, Petitioner's

“scheme” theory would create great uncertainty for banks

and other financial institutions. If this theory were adopted.

plaintiffs’ lawyers routinely could bring cvercive class

actions aguinst such institutions seeking many millions. and

often billions. in damages hased solely on a bank's

participation in lending and other financial transactions. In

these circumstances. this Court should not overturn

Congress's explicit decision in the PSLRA to entrust the

responsibility for deciding when to prosecute alleged aiders

and abettors of securities traud to the expert judgment of the

SEC.

4

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A. Petitioner’s Vague “Purpose and Effect” Test

Cannot Be Rationally Administered and Would

Lead to Arbitrary Results.

In support of its “purpose and effect” test, Petitioner

tries to draw a distinction between “legitimate” and

“illegitimate” transactions on which the question of primary

liability would turn. (See Pet. Br. 6-8, 12, 14.)’ Ignoring the

statutory elements of a Section 10(b) claim. Petitioner

proposes that banks and other secondary actors that engage in

“legitimate” transactions with an intent to further a fraud are

merely aiders and abettors, while those that engage in

“illegitimate” transactions to further a fraud are primary

violators. In proposing this standard, Petitioner makes no

effort to define coherently “legitimate” or “illegitimate”

transactions or to explain how federal judges around the

Nation would apply this vague standard in deciding motions

to dismiss and for summary judgment. On its face, such a test

has no place in the law, much less in “*an area that demands

certainty and predictability.” Central Bank, 511) U.S. at 188

(quoting Pinter v. Dahi. 486 U.S. 622. 652 (1988)). In

application, Petitioner's proposed standard would “lead{] to

the undesirable result of decisions ‘made on an ad hoc basis,

offering little predictive value’ to those who provide services

to participants in the securities business.” Ad.

Making matters worse. Petitioner's ambiguous and

fuct-intensive standard would create a factual dispute in

virtually every cuse. making it extremely difficult for

innocent defendants to wtain dismissal of even the most

dubious claims. Indeed. bi-partisan groups have recently

concluded that this type of ligation uncertainty and risk ts

One of Petioner’s amie: goes even turther. suggesteng that lability

turn upen whether the “busemess purpose” for the transaction

substanual or “insubstantial.” (Bro of N-Y. State Teachers’ Ret. Svs. et al.

12-13 n.6.)

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severely damuging the competitiveness of the U.S. capital

markets.”

In the face of years of litigation and the risk of

massive damages at 4 trial, many banks and other financial

services companies will have no choice but to abandon their

defenses—regurdless of the merits of those defenses—and to

pay expensive settlements.” The risk of crippling jury awards

means that “even a complaint which by objective standards

may have very litte chance of success at trial has a

settlement value to the plaintiff out of any proportion to its

prospect of success at trial so long as he may prevent the suit

For example. a bi-partisan commission recently formed by the U.S.

Chamber of Commerce to study the current state of the US capital

markets concluded that the legal standard advocated by the Petitioner

here would increase the cost of raising capital in the United States.

COMM'N ON THE REGULATION OF U.S. CAPITAL MKTS. IN THE 21>

CENTURY. REPORT AND RECOMMENDATIONS 90-92 (Mar. 2007).

available at hiip://www cuschamber.con/publications/reportsA070 3capmar

ketscomm. him.

' Congress has recognized that “basic economies” can force detendants

lo settle “meritless” class actions that have “only a five percent chance of

success” if the defendants are unable to obtain carly dismissal. S$. Rep.

No. 109-14. at 21 (2008). as reprinted in 2005 US.CCLA.N. 3. 21: see

also §. Rep. NO. 104-98. at 7 (1995). as reprinted in 1995 US.C.C_ AN.

679. 686 (if the deicadam “cannot win an carly dismissal.” simple

economics “may dictate a settlement even if the defendant is relatively

confident that 1 would prevail at trial”) (quoting statement of former SEC

Chairman Arthur Levitt). Studies confirm that virtually every securities

fraud claim that survives a motion to dismiss is settled: few hesinesses

can afford to risk a trial. regardless of the merits of the claim. See

RICHARD PAINTER FT AL. PRIVATE SkCURITIES LITIGATION REFORM

ACT: A POST-ENKON ANALYSIS 7 (Federalist Soe's for Law & Pub. Pols

Studs. 2002) ("ne case has been tricd since the PSLRA went into effect:

all have either been settled of dismissed”): Janet Cooper Alexander. Do

the Merits Matter’ A Study of Settlements in Securities Class Actions, 43

Stan. L. Rev. 497 (1991): Patrick M. Garry et al. The irrationality of

Shareholder Class Action Lawsuits, 49 SD. L. Rev. 275. 287 0.98 (2004)

(citing studies)

16

from being resolved against him by dismissal or summary

judgment.” Blue Chip Stamps v. Manor Drug Stores, 421

U.S. 723. 739-40 (1975) (observing that “litigation under

Rule 10b-5 presents a danger of vexatiousness different in

degree and in kind from that which accompanies litigation in

general”); accord Virginia Bankshares, Inc. v. Sandberg, 5O\

U.S. 1083, 1106 (1991) (“The issues would be hazy, their

litigation protracted, and their resolution unreliable. Given a

choice, we would reject any theory...that raised such

prospects....°). The threat of costly and disruptive

discovery adds an additional “in terrorem increment” to the

settlement value of even meritless claims. Blue Chip Stamps,

421 U.S. at 741. For that reason, this Court has repeatedly

rejected open-ended rules of uncertain application that would

make Section 10(b) cuses “virtually impossible to dispose of

prior to trial other than by settlement,” “no matter how

improbable the allegations.” /d. at 742. Similarly, Congress

sought to reduce the number of vexatious lawsuits in

enacting the PSLRA.'”

B. Petitioner's “Purpose and Effect” Test Would

Deter Beneficial Economic Activity by Financial

Services Companies.

Petitioner's “purpose and effect” test would subject

nearly every form of business transaction. including normal

Le

See S. Rep. No. 104-98. at 19 (1995). as reprinted in 1995

U.S.C.C.A.N, 679. 698 (“amending the 1934 Act to provide explicitly fos

aiding and abetting lability actions under Section 10th) would be

contrary to [the}| goal of reducing mentless securitios hiigation.”). 141

CONG. Rec. S8896 (deily oh June 22. 1995) (statement of Sen.

Domenech) (lt ty time that We stop vexatious securtties litigation. and fix

it weowill “). see alse HER. Rev. No. 104-369, at 32 (1995) (Cont. Rep.).

as reprinted im WIS U.S.C.C_AN. 730. 731 (This Conference Report

seeks to protect investors. mssuers. and all who age associated with our

capa) markets from abuswe sceuntices bugation. This legislation

implements needed procedural protections to discourage frivolous

litigainon.)

17

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commercial lending and other financial transactions, to

challenge in a securities fraud class action. Structured finance

transactions and derivatives transactions, such as those

engaged in by Amici’s members to meet the needs of their

customers, would be particularly vulnerable to coercive

litigation because of the complexity of such transactions.

Every day. the U.S. banking industry engages in a

wide variety of activities that finance the spending and

investment of large and small businesses and enable them to

enguge in risk mitigation. Such transactions take many

forms. and they are often structured by the borrower to

achieve the most beneficial legal. tax or accounting result—a

practice that is both legitimate and commonplace. The

dynamic nature of accounting. tax and other regulatory rules

lurther contributes to the complexity of such transactions and

the need for innovation. as companies seek to customize

iransuctions 10 meet their unique needs through such

“structured finance” transactions.

Structured finance is critically important to the

strength and growth of our economy. In these transactions, a

company satisfies its goal of receiving funds. while at the

same time meeting various other objectives. including

minimizing or altering its risks. affecting the manner in

which an asset and/or debt will be held. and lowering the cost

of capital and funding."

See Oversight of Investment Banks” Response to the Lessons of Enron:

Hearme Before the Permanent Subcomm. of Investigations of the S.

Comm. on Governmental Affairs. VO7th Cong. 120 (2002) (statement of

Richard Spillenkothen. Federal Res eve. Director. Division of Banking

Supersision and Regulation) [herematicr Spillenkothen testimony | CTO

the economy's benefit. the structured finance business has led to a lower

cost of cupital to businesses and consumers. which has helped fuel greater

aceess to credit and Jonger term growth 1 ad. at 134 (statement of

Annette Nazareth. SEC. Director, Division of Market Regulatson (and

now an SEC Commissioner) (Structured finance plays an important role

1%

The U.S. banking industry also engages in a large

volume of derivatives transactions cach year. As of year-end

2006, U.S. banks held derivatives with a notional value of

$131.5 trillion. while the notional valuc of derivatives

outstanding globally amounted to $327.3 tillion.'” The

banking industry uses derivatives transactions to protect

against risks to which banks and their customers are exposed,

including interest-rate or foreign-cxchange-rate movements

and credit-default risks.

Many of these transactions are inherently complex

and customized and present difficult accounting issues and

judgments even for professional accountants.'* Accountants

and other professional advisors for large companies spend

literally thousands of hours reviewing such transactions (and

the issuer's financial statements) for the purpose of

determining the issuer's compliance with tax, accounting and

other legal obligations. — '

It is counterproductive, and contrary to Congress's

intent and sound public policy, to expect financial institutions

to police the accounting judgments of their public-company

counterparties. Financial institutions generally are in no

position to do so, and such institutions should not he subject

in the modern business environment. When used properly. i can provide

needed liquidity and funding sources, investment opportunities, and can

facilitate risk dispersion.)

OFFICE OF THE COMPTROLLER OF CURRENCY. OCC'S REPORT ON

BANK DERIVATIVES ACTIVITIES, FOURTH QUARTER 2006 7, 9 (2006).

available at hup://ww ww oce.treas. gos /tp/deris /dg406.pdty Intl Swaps &

Derivatives Ass'n. Summartes oof Market) Survey Results.

hip://www .isdaorg/statisties/recent. html (last visited August 7, 2007).

See. e.g. Todd Davenport. The Uneven Evolution of Accounting

Standards, AMERICAN BANKER, July 28. 2004. at 17 (Derivatives ts the

hind of thing where even the people trying to do it mght end up making

honest mistakes because it can be pust so rmmensely complicated.” >.

19

lo coercive securities Class actions if those judgments by their

counterparties and their advisors turn out to be incorrect or

subject to dispute.'* But Petitioner's proposed standard

would impose such a burden on banks and thus would deter,

or at least sharply raise the cost of. derivatives and

structured-finance transactions, significantly eliminating the

benefits of such transactions for U.S. businesses.

These costs are wholly unwarranted. particularly

becuuse Congress in the PSLRA expressly authorized the

SEC to bring enforcement actions against, and levy

substantial fines on, aiders and abettors. In addition, the

prospect of prosecutions and other actions by the Department

of Justice, state attorneys general. and self-regulatory

organizations such as the Financial Industry Regulatory

Authority. provides another meaningful layer of deterrence

against such conduct and penalties for misconduct that accrue

to investors who have been harmed. In contrast, Section

10(b) suits often serve to enrich lawyers, while providing

relatively litthe compensation — for investors.'” In these

! a .

’ See Spillenkothen Testimony. supra note Eh. at 119 (stating that banks

should not “be required to second guess their customer's accountants, tax

of legal experts or police their customer's activities. Such an expectation

would require. inappropriately. banking organizations to assume

management responsibility for their customers. place potential legal

liabilny on banking organizations that would compromise their ability to

pertorm their role as financial intermediaries or threaten their satety and

soundness, and place significant costs on banking organizations to audit

the activities of their customers.” ).

See John C. Coflee. Jr. Reforming the Securities Class Action. 106

Comes. L. REV. 1534. 1538 (2006) (Securities class actions essentially

Impose costs on public shareholders ins order to compensate public

sharcholders. This ts a circular process whose perverse effects are

compounded by the twin tacts that tay public shareholders tend to be

diversified Gand thus are on both sides of the wealth transfer). and ¢b) on

each such transfer a significant percentage of the transfer payment goes to

lawsers and other agents.”). Indeed. a studs of 500 securities fraud class

actions filed after passage of the PSLRA concluded that thes destroved

20)

circumstances, this Court should not create a cause of action

that would upset the policy judgment that Congress made in

the PSLRA.

Ii. THE COMMON LAW DOES NOT SUPPORT

PETITIONER’S “SCHEME” THEORY.

Several of Petitioner's amici try to support

Petitioner's expansive reading of Section 10(b) by claiming

that it is justified because the Vendors’ conduct constituted

actionable fraud at common law, which Congress sought to

expund with the 1934 Act. (See Br. of N. Am. Sec.

Administrators Ass'n, Inc. (*"NASAA Br.”) 7-8: Br. of Am.

Ass'n tor Justice (“AAJ Br.”) 12-16, 18: Br. of Change To

Win and the CtW Investment Group (“CTW Br.”) 4-5, 12-13,

18-19.) These arguments ure misplaced.

First, whatever the state of the common law in 1934,

this Court has since authoritatively construed the meaning of

Section 10(b) and determined that this statute does not reach

conduct, such as the Vendors’ conduct here, that constitutes

aiding and abetting, a conclusion that Congress subsequently

ratified in the PSLRA. In any event, Petitioner could not

have recovered aguinst the Vendors in an action for common

luw fraud, al most, the Vendors’ conduct would have

umounted to a common law aiding-and-abetting claim. which

cannot be imported into Section 10(b).

This appeal to the purported common law antecedents

of Section 10(b) is not new. Notably, Petitioner's amici today

on average 3.5 percent of the equity value of the defendants. resulting in

$25 billion in shareholder wealth being “wiped out just due to litigation.”

ANIAN V. THAKOR, THE UNINTENDED CONSFOUENCES OF SECURITIES

LITIGATION 14 ¢U.S. Chamber Institute for Legal Reform 2005).

available at http://www unstitutelorlegalretorm.org/issues/docload.ctm”?

docld=857. By reducing the equity value of defendants. abusive securities

lraud litigation results in lower capital investment. which in turn “has

obvious implications for job creation and ccononmuc growth.” dd.

2

invoke the same appeals to the common law in support of

“scheme” liability that respondents in Central Bank

unsuccessfully raised in trying to persuade this Court that

Congress intended Section 10(b) to include a cause of action

for aiding and abetting. Bricf for Respondents at *15-17.

Central Bank, 511 U.S. 164 (No. 92-854), 1993 WL 407323.

The only difference between the arguments advanced by

respondents in Central Bank and the arguments of

Petitioner's amici here with respect to common = Jaw

“antecedents” 1s that the former used the phrase “aiding and

ubetting™ and the Jatter use the word “scheme.”

A. The Common Law Has No Bearing on the

Interpretation of Section 10(b).

In passing the 1934 Act, Congress did not create or

intend to create the private mght of action the courts

subsequently implied under Section 10(b). See Blue Chip

Stamps, 421 U.S. at 729-30 (legislative history does not

provide “any indication that Congress considered the

problem of private suits under [Section 10(b)] at the time of

its passage” and “there is no indication that the Commission

in adopting Rule 1Ob-5 considered the question of private

civil remedies under the provision”): see also Lamp. Pleva,

Lipkind. Prupis & Petigrow vy. Gilbertson, 501 U.S. 350,

358-59 (1991). Thus. Congress could not have intended to

import the common law to construe a cause of action it did

not create.

Because the private Section |0(b) cause of action ts

an implied right of action, reliance on tort principles for

interpretation “is entirely misplaced.” Touche Ross & Co. Vv.

Redington, 442 U.S. 560, 568 (1979) (declining to recognize

imphed private right of action under Section 17(a) of the

1934 Act based on common law tort principles): see also

Central Bank, 511 U.S. at 178. 184: Pinter. 486 U.S. at 649,

652 (construing Section 12 of the 1933 Act: rejecting

plaintiffs” interpretation. which was “grounded in_ tort

doctrine.” finding “no congressional intent to incorporate tort

aie)

law doctrines”); Virginia Bankshares. 501 U.S. at 1110

(Scalia, J.. concurring) (reliance on tort law inappropriate

because “the federal cause of action at issue here was never

enacted by Congress”).

Reliance on common law ts especially inappropriate

where, as here, this Court has interpreted the statutory

lan.uage in question. “[WJhere the Supreme Court has

authoritatively construed the pertinent language of the statute

giving rise to the plaintiffs’ cause of action, the common law

meaning of that language is irrelevant.” Regents, 482 F.3d at

389, As this Court noted in Zandford, Section 10(b) “must

not be construed so broadly as to convert every common-law

fraud that happens to involve securities into a violation of

§ 10(b).” 535 U.S. at 820: accord Marine Bank v. Weaver.

455 U.S. 551. 556 (1982) (“Congress, in enacting the

securities laws, did not intend to provide a broad federal

remedy for all fraud.”).

B. “Scheme” Claims Would Amount to No More

Than Aiding and Abetting or Conspiracy Claims

at Common Law.

1. Common Law Fraud Requires Reliance by the

Plaintiff on the Defendant's Misrepresentation.

Petitioner's fraud claims against the Vendors would

have failed at common law in 1934 on one of the primary

buses such claims fail under Section 10(b) today—lack of

reliance.

The cause of action tor “deceit.” the predecessor to

fraud at common law, was not an expansive one.'” Indeed, as

"See LOUIS Loss & JOEL SELIGMAN, FUNDAMENTALS OF SECURITIES

REGULATION YLO (Sth ed. 2004). The common law elements of a cause

of action for deceu’ were (1) a false representation of (2) material fact

(3) Knowingly made by the defendant tor the purpose of inducing plant!

to rely on it. (4) pustihable reliance bs plaiultl and (5) resulting damages.

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Professors Loss and Seligman note, at common law, “[iJn

effect, the charge of deceit . . . is an accusation of thievery.”

Louis Loss & JOEL SELIGMAN, FUNDAMENTALS OF

SECURITIES REGULATION 911 (5th ed. 2004).

When Congress enacted the 1934 Act. the law of

deceit was well-illustrated by the landmark English case of

Peek vy. Gurney, (1873) L.R. 6 H.L. 377. In that case. the

House of Lords held that directors of a corporation were not

liable for deceiving a plaintiff who relied on false

representations made in a prospectus authored by those

defendants because the directors had no dealings with

plaintiff and did not intend that plainuff rely on the

representations in question, which were directed only at

initial purchasers of the company’s stock. In that decision.

Lord Chelmsford, after an extensive review of precedent.

explained the rule:

lt appears to me that there must be something to

connect the directors making the representation with

the party complaining that he has been deceived and

injured by it: .... In all these cases the parties in one

way or another are brought” into direct

communication: and in an-— action — the

misrepresentation would be properly alleged to have

Id. at 399-400. Lord Colonsay similarly concluded that “in a

cause of this kind it is necessary to make out some direct

connection between the directors and the party who alleges

that he was deceived.” /d. at 401.

Courts addressing fraud claims after Peek repeatedly

cited and relied on that decision to reject claims that were not

based on direct communications.’ In order to recover. it was

Sec. ¢.g.. Hindman \. First Natl Bank of Louisville, 142 F. 931. 942-

43 (6th Cir, 1902) (colt has never been a ground of action that the

defendant made a dishonest representation. and that the plainutl relied

24

necessary for plaintiff to show, among other things, that the

plaintiff relied on the defendant's misrepresentation. Because

the plaintiffs did not rely (and could not rely) on anything the

Vendors said or did, Petitioner's claim against the Vendors

therefore would have failed at common law.

2. The Common Law Authorities Cited by

Petitioner’s Amici Do Not Support Its

“Scheme” Theory.

Petitioner's amici cite numerous decisions in support

of their argument that the Vendors would be liable at

common law, but notably, Peek v. Gurney is not among

them. Furthermore, their discussion of the cause law is

characterized by both a disregard of the pertinent facts and

holdings and a preoccupation with dicta in those decisions,

none of which in any event remotely resembles the facts

alleged to create liability against the Vendors here. As this

Court has noted, “the typical fact situation in which the

Classic tort of misrepresentation and deceit evolved was light

years away from the world of commercial transactions to

which Rule 10b-5 is applicable.” Blue Chip Stamps, 421 U.S.

ut 744-45.

upon it and sustained injury... . unless {the plainulf is} able in one way

or another to bring [himsell} within the class of persons for whom the

representation was intended.”), Merchants’ Natl Bank \. Armstrone. 65

F. 932. 939. 940 (C.C.S8.D. Ohio 1895S) CoThat such a [false]

representation was so made somewhere. al some time. to some person, by

the persons sought to be charged. 1s not sufficient: it must be made to the

person seeking to charge them”): Dinsmore .. National Hardwood Co..

208 N.W. 701. 702. 703 (Mich. 1926) (plaints traud claim against

defendant fails even though delendant knowingly made — false

representation on which planull rehed because phuntiffs mjury “too

remote) (quoting Hindman, 112 F. at 9410 Brackett .. Griswold, 20

N.E. 376. 380. 381 (N.Y. 1889) (ln order to recover in an action for

fraud and decent the fraud and injury must be connected.” >

Most of the decisions cited by Petitioner's amici

involve a situation where the defendants themselves had

direct dealings with the plaintiff and/or engaged in the

fraudulent acts on which the plaintiff relied, causing plaintiff

injury. See, ¢.g.. Pennebaker v. Kimble, 269 P. 981, 984 (Or.

1928) (plaintiff dealt directly with defendants, whose conduct

falsely represented facts on which plaintiff relied); Crompton

v. Beedle, 75 A. 331, 332 (Vt. 1910) (defendant-purchaser

defrauded plaintiff-seller of land parcel by affirmative

representation that was incomplete and hence misleading):

Noved Realty Corp. v. A.A.P. Co., 293 N.Y.S. 336, 340-41

(App. Div. 1937) (to the same effect): Stewart v. Wyoming

Cattle-Ranche Co.. 128 U.S. 383, 383-84 (1888) (same):

Laidlaw v. Organ, 15 U.S. (2 Wheat.) 178, 185-90 (1817)

(same). In other cases. defendants who did not have direct

dealings with the plaintiff were held liable on agency

principles. See. ¢.g.. Downey v. Finucane, 98 N.E. 391, 393

(N.Y. 1912): Purdum v. Edwards, 141 A. 550, 553 (Md.

1928).""

Petitioner's amici also seek to rely on various

common law doctrines that are inupposite, distorted, or, in

one cuse, non-existent, in an attempt to excuse their inability

to satisfy the reliance requirement of « common law fraud

claim.

Misrepresentations by = “Conduct.” Some _ of

Petitioner's amici argue that the Vendors may be liable

because they made misrepresentations by “conduct.” (See

CTW Br. 14-17: see also AAJ Br. 14 (common law

recognized “that fraud can be effected by conduct”): id. at

16-17 (citing RESTATEMENT (FIRST) OF TORTS §§ 525, 533

Pewnoner does not contend that the Vendors could be lable because

Charter was their agent. and in any event Congress enacted a specilic

provision in the 1934 Act to define the scope of secondary lability fora

Section LOCb) srehation. See 1S USC. $ 78teas.

26

(1938).) This argument is a red herring. The Eighth Circuit

did not hold, and Amici do not argue, that conduct cannot be

the basis for a securities fraud claim. Rather, as the cases

cited by Petitioner's amici demonstrate. the conduct at issue

must itself deceive the plaintiff. See, e.g., District Motor Co.

v. Rodill, 88 A.2d 489, 493-94 (D.C. 1952) (liability for

turning back odometer of car to “represent” to plaintiff that

car was newer than it was): Salzman v. Maldaver, 24 N.W.2d

161. 167 (Mich. 1946) (defendant-seller defrauded plaintiff-

purchaser in sale of aluminum sheets by placing undamaged

sheets on top of each bundle of corroded and damaged sheets

und thereby deceiving plaintiff as to quality of aluminum):

Lindberg Cadillac Co. v. Aron, 37\ S.W.2d 651 (Mo. Ct.

App. 1963) (defendant-seiler defrauded plaintiff-purchaser in

sale of car by painting over a crack in car's motor block).

Here, by contrast. Petitioner does not allege or

contend that the Vendors’ conduct itself deceived any

investor. Rather, using the Aron decision by way of example.

the Vendors’ conduct cannot be compared to a car salesman

painting over a crack to deceive the car buyer: ut most, the

Vendors’ conduct is analogous to paint shops that solid the

paint allegedly knowing that the salesman would use the

paint for such a purpose. Or, in Rodill, the Vendors’ conduct

is equivalent to the car manufacturer that failed to install a

tamper-proot lock on the odometer allegedly knowing that it

was very likely that the odometer would be tampered with to

deceive prospective purchasers.

Viewed most favorably to Petitioner, the Vendors’

conduct here amounted to a representation that the

lransactions at issue occurred on a particular date and that the

pricing increase for the set-top boxes sold to Charter was due

to increased manufacturing costs.'” It is undisputed that no

iD ‘ e — 9 °

Amicus Change to Win’s argument that the Vendors’ conduct

“umounted to an asscruion regarding the financial condition of Charter

a

such misrepresentations were made to, or relied upon by,

Petitioner and other investors. The purported misrepre-

sentations on which plaintiffs relied concerned the reported

financial condition of Charter, which misrepresentations

were made by Charter, nor the Vendors, and which required

Charter’s intervening application of accounting rules.

Certain of Petitioner's amici also cite Section 533 of

the RESTATEMENT OF TORTS. (See AAJ Br. 17-18; Br. tor

Amici Curiae States of Arkansas et al. 24-26.) Section 533

has no bearing here because Charter’s investors did not rely

on any “information” furnished by the Vendors. (Cf. Br. for

Amici Curiae States of Arkansas et al. 26 (positing that

“relevant question is whether information supplied by the

(anonymous) actor was relied upon by the public™).) Rather.

Petitioner alleges that the Vendors “backdated” and

otherwise falsified transaction documentation that was not

seen, or intended to be seen, by investors, but instead was for

the purpose of deceiving Charter’s auditors so as to enable

Charter to misrepresent the cash flows and revenues

ussociated with those transactions to its investors. This

alleged pattern is easily distinguishable from the scenario

described in Section 533. which, in addition to requiring

reliance by the plaintiff (absent here). requires that the

misrepresentation be “made to a third person for the purpose

of having him repeat its terms or communicate its substance

to” the plaintiff.

“Liability for All Participants in a Fraud.” Certain of

Petitioner's amici claim that the Vendors would be liable for

fraud at common law. because “the common law of fraud

that was not im accordance with the truth” «CTW Br. at 16) ts without any

foundation. The alleged conduct of the Vendors could not have

constituted such a “representation” even to Charter’s auditors (the only

ones alleged to have seen the documents in question). much less Charter’ s

INVCSLOFS

historically attached primary liability to all of the participants

in a fraudulent scheme.” (NASAA Br. 9.) But this argument

completely fails to distinguish liability for engaging in fraud

from liability for aiding and abetting or conspiring to commit

such fraud.~’ Indeed, Petitioner's amici do not dispute that

common taw liability for aiding and abetting fraud predates

the 1934 Act. See, e.g.. Hobbs v. Boatright, 93 S.W. 934,

539-40 (Mo. 1906): Virtue v. Creamery Package Mfg. Co..

142 N.W. 930, 939 (Minn. 1913) (those who “aid or abet™ a

tort are “jointly and severally liable therefor”): White v.

Moran, 134 Ill. App. 480, 491-92 (App. Ct. 1907); Judson v.

Cook, 11 Barb. 642. 644 (N.Y. Gen. Term 1852); see also

RESTATEMENT (FIRST) OF TORTS § 876(b) (1939). In Central

Bank, this Court made clear that aiding-and-abetting liability

was not imported into Section 10(b) by Congress. 511 U.S. at

184-85.

Petitioner's amici simply do not distinguish between

liability based on aiding ‘and abetting and conspiracy and the

liability of a primary wrongdoer, which among other things

requires reliance. Thus, for example. in holding the detendant

liable for aiding and abetting. the Hobbs court acknowledged

that plaintiff could not establish a primary fraud claim

against the alleged aider and abettor because. as here. the

plaintiff could not prove reliance. 93 S.W. at 939.

* Respondents in Central Bank and certain of ity amici (as well as the

SEC) made similar common law arguments to try and persuade the Court

that Section 1OCb) prohibtted aiding and abetung. arguing that by 1934

common law lability tor aiding and abetting was “well-established.” See

Brie! tor Respondents at “1S. Central Bank. S11 U.S. 164 (No. 92-854).

1993 WL 407323. Bret for the Securities and Exchange Commission as

Amicus Curtac in Support of Respondents at “10. Central Bank. SLL US.

164 (No. 92-854). 1993 WL 13006275: Brief of Amicus Curiae Trial

Lawyers for Public Justice et al. in Support of Respondents at 13.

Centra! Bank. SVT US. 164 (No. 92-854). 1993 WL 13006270.

29

“Duty Not To Commit Fraud.” One amicus, Change

to Win, maintains that the Vendors’ “fraudulent conduct

umounted to a misrepresentation and concealment,” and that

the Vendors had a common law duty to refrain from such

conduct because “one who acts inherits a duty to act

nondeceptively.” (CTW Br. 22: see also id. at 18-23.)

Change to Win cites no authority for this proposition,”

which directly contravenes Central Bank. Change to Win

claims that a duty is not required to impose liability on the

Vendors because “a duty to refrain from fraudulent conduct”

suffices. (dd. at 22.) Even putting aside the circular

reasoning of this argument. neither the common law nor

federal securities law imposes a duty of disclosure on the

Vendors to plaintiffs, to whom the Vendors never

communicated at all, whether through words or conduct.

CONCLUSION

For the foregoing reasons, the judgment of the court

of appeals should be affirmed.

‘This is unsurprising. as the common law was to the contrary. See. ¢.¢..

Harrys Shulman. Civil Liability and the Securities Act, 43 Yaub L. J. 227,

238-39 & n.46 (1933) (Both in [common law] acgligence and ip decett.

the issue as to whether or not the defendant owed any duty to the

particular plainull with respect to the representations is primary... . That

issuc has insulated a large class of persons involved on the seller's side in

the sale Of securities against misrepresentation suits by a large class of

mMvestors.”) (CHING Cases).

Change To Win purports to distinguish thes Court's insider trading

cuses as cases involving “pure silence” rather than “conduct” because the

trading activity is “not tself deceptive in nature.” (CTW Br. 21-22 &

n.20.) This distinction makes no sense. This Court has determined in

those cases that the “conduct” of trading securities based on the

possession of material. non-public information is “decepuse” only when

its done in violation of a fiduciary duty to disclose. See. ¢.g.. Chiarella.

445 US. at 2M see alse O Hagan, S21 US. at 660,

30

Duted: August 15, 2007

Respectfully submitted,

H. Rodgin Cohen*

David H. Braff

Robert J. Giuffra, Jr.

Mare De Leeuw

Jeffrey T. Scott

Steven J. Purcell

SULLIVAN & CROMWELL LLP

125 Broad Street

New York, NY 10004

(212) 558-4000

Counsel for Amici Curiae

American Bankers Association,

The ABA Securities

Association, The Clearing

House Association L.L.C.

and The Financial Services

Roundtable

*Counsel of Record

ee

SS aa