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

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URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0280%3A15

## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 2008
- **Citation:** 552 U.S. 148

## Text

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

Rn

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
4
_
4
«

—, “as °e° Ee

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.
hd.

tv
a

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

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0280%3A15. Public record. Not legal advice.