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

a sm

99 FILED ~

No. 06-43 | AUG { 4 20N7

IN THE SUPREME COURT. ne

Supreme Court of the Gnited States

STONERIDGE INVESTMENT PARTNERS, LLC.,

Petitioner,

v.

SCIENTIFIC-ATLANTA, INC. AND MOTOROLA, INC..,

Respondents.

On Writ of Certiorari to the United States

Court of Appeals for the Eighth Circuit

BRIEF FOR THE AMERICAN INSTITUTE OF

CERTIFIED PUBLIC ACCOUNTANTS AS AMICUS

CURIAE IN SUPPORT OF RESPONDENTS

RICHARD I. MILLER LAWRENCE S. ROBBINS*

American Institute of GARY A. ORSECK

Certified Public Accountants KATHRYN S. ZECCA

121] Avenue of the Americas Robbins, Russell, Englert,

New York, NY 10036 Orseck & Untereiner LLP

212) 596-6200 1801 K Street, N.W.

Suite 41]

Washington, D.C. 20006

(202) 775-4500

* Counsel of Record

Counsel for Amicus Curiae

American Institute of Certified Public Accountants

TABLE OF CONTENTS

Page

re errr iii

[INTEREST OF THE AMICUS CURIAE.........-...---

INTRODUCTION AND SUMMARY

NT weal 2

SERRE ST See eee era ae rp apnea 5

I. WHERE INVESTORS ARE INJURED BY AN

ISSUER’S FALSE FINANCIAL STATEMENTS,

LIABILITY UNDER SECTION 10(b) EXTENDS

ONLY TO THOSE PARTIES WHO ACTUALLY

MADE THE MISSTATEMENT. ..........-...... 5

A. Allowing A Misstatement Case To Be

Recharacterized As A “Deceptive Conduct”

Or “Scheme” Case Is Inconsistent With The

Text Of Section 10(b) And With This Court’s

LG bab dc Cb Rae NA Renek Wee bedaw ese ces 6

B. Petitioner’s “Purpose And Effect” Test Does

Not Successfully Distinguish Garden- Variety

Aiding And Abetting From True “Primary

DT 75 5ticeukesehs sasasiseeeeadanss 13

Il EXTENDING LIABILITY FOR’ FALSE

STATEMENTS TO PERSONS WHO DID NOT

MAKE THEM WOULD IMPAIR THE QUALITY OF

FINANCIAL REPORTING BY _ PUBLIC

CRP 6 vb aces veedesevceseceoecutenevc 15

TABLE OF CONTENTS - cont’d

Page

A. The Open-Ended “Purpose And Effect” Test

Would Dissuade Auditors From Performing

Services That Are Beneficial To Public

Companies And Their Investors. ............. 17

B. Auditors Are Especially Vulnerable To

Vexatious Securities Class Actions, And

Thus Stand To Be _ Disproportionately

Harmed By The Rule Advocated By

DELS CCceCSCKRed cae ee cee ee seas 22

NE vs ko 506 bane hdaneees aN Ruonsebewan 26

TABLE OF AUTHORITIES

Page(s)

Cases:

Bailey v. United States, 516 U.S. 137 (1995). .......... 11

Basic Inc. v. Levinson, 485 U.S. 224 (1988). .......... 1,5

Blue Chip Stamps v. Manor Drug Stores,

a ad onc a win we 6 Gti 15

Brennan v. Midwestern United Life Ins. Co.,

259 F. Supp. 673 (N.D. Ind. 1966)............... 2,3

Central Bank of Denver, N.A. v.

First Interstate Bank of Denver, N.A.,

ne is ae Vakbateeeee passim

Chiarella v. United States, 445 U.S. 222 (1980)......... 10

Cooper v. Pickett, 137 F.3d 616 (9th Cir. 1997)......... 12

-Credit Suisse Securities (USA) LLC v. Billing, |

le ee eee cb e ees 16

Cumis Ins. Society, Inc. v. E.F. Hutton & Co.,

457 F. Supp. 1380 (S.D.N.Y. 1978)................ 3

- Dura Pharmaceuticals, Inc. v. Broudo,

se ek eu ie pa sensenes 1,24

Edwards & Hanly v. Wells Fargo Sec. Clearance Corp.,

oe | re 14

Ernst & Ernst v. Hochfelder,

I ccs cecchsecisenden cae 1,7,8

iv

TABLE OF AUTHORITIES - cont’d

! Page(s)

Fed. Deposit Ins. Corp. v. First Interstate Bank

of Des Moines, N.A., 885 F.2d 423 (8th Cir. 1989). ... 3

GFL Advantage Fund, Ltd. v. Colkitt,

Bae Cae Se I ok ks ch occvenscdceueden

In re Ancor Communications, Inc.,

22 F. Supp. 2d 999 (D. Minn. 1998)............... 23

In re IKON Office Solutions, Inc.,

Figg 2 ek i rere erry 22

In re IKON Office Solutions, Inc. Sec. Litig., 7

131 F. Supp. 2d 680 (E.D. Pa. 2001). ............. 19

In re Kendall Square Research Corp. Sec. Litig.,

868 F. Supp. 26 (D. Mass. 1994). ................ 19

In re Miller Indus., Inc. Sec. Litig.,

12 F. Supp. 2d 1323 (N.D. Ga. 1998).............. 23

In re Seracare Life Sciences, Inc. Sec. Litig.,

No. 05-CV-2335-H (CAB), 2007 WL 935583 (S.D.

Ce Se SO is 9X 3.k0 4000 seedsvseeeeel 19

Landy v. Fed. Deposit Ins. Corp.,

oe Os err 2

Lattanzio v. Deloitte & Touche LLP,

SPO FOO 8467 CRBC, BOER «ccc ccccvsvcccese 17, 20

Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,

Bae Te VOT EG: EOD 6.6.4.0 600nd00eensueen 5

Vv

TABLE OF AUTHORITIES — cont’d

Page(s)

Pinter v. Dahl, 486 U.S. 622 (1988). ...........4.. 14, 15

Renovitch v. Kaufman,

905 F.2d 1040 (7th Cir. 1990). ..............00.. 14

Rhode Island Hosp. Trust Nat'l Bank v. Swartz,

— & 23

Santa Fe Indus. v. Green,

ee is os Cases ceseen 6, 8,9

Schatz v. Rosenberg,

943 F.2d 485 (4th Cir. 1991). ................ 13, 14

SEC v. Zandford, 535 U.S. 813 (2002). ... 2.2.2.6... cee 9

Shapiro v. Cantor, 123 F.3d 717 (2d Cir. 1997). ........ 12

Simpson v. AOL Time Warner, Inc.,

452 F.3d 1040 (9th Cir. 2006). ................... 13

Tellabs, Inc. v. Makor Issues & Rights, Ltd.,

a tincckvighehetecseccceees |

Thor Power Tool Co. v. Commissioner of Internal Revenue,

ee ce deaktaseensececess 22

United States v. Arthur Young & Co.,

I cc cccdccovecccecececcecees 18

United States v. O'Hagan, 521 U.S. 642 (1997).......... y

United States v. Peoni,

Ec ce ccs eeesececees 2

vi

TABLE OF AUTHORITIES -— cont’d

Page(s)

United States v. Sayetsitty,

oof a fo fl 8 rr 14

Wright v. Ernst & Young LLP,

Seen ee OG BUUD o ce oc ccccceccececsss 19

Statutes, Regulations, & Other Legislative Authorities:

SED co. bades aay bwkdedcinka ee enbae passim

nt bn nsscCeounvecnesescenacubeseel 17

PN as wit eis ch eeeeabeceeunaaens 3, 25

PE us cdnGvdceedecscuvaseous 18, 19

ee BONNE. oo oc. ckicaccuces passion

Private Securities Litigation Reform Act of 1995,

SN Ser PE Uo oc bdndecsscddsneteses 3

Te GU, FE, DOP CUUO svc ccc ccceccccccseens 16, 25

Miscellaneous:

1A FED. JURY PRAC. AND INSTR. § 18.01 (Sth ed. 2000)... 14

Daniel L. Brockett, Line Between Primary and

Secondary Liability Still Blurred in Securities Cases,

Eo hvbdwskovankinhvaows 23

Alan R. Bromberg & Lewis D. Lowenfels,

Aiding and Abetting Securities Fraud: A Critical

Examination, 52 ALB. L. REV. 637 (1988). ........ &®

vii

TABLE OF AUTHORITIES -— cont’d

Page(s)

D.R. CARMICHAEL, O. RAY WHITTINGTON &

LYNFORD GRAHAM, ACCOUNTANTS’ HANDBOOK,

DEORE GME ccc ccececesonccceses 18, 22

Jack T. Ciesielski & Thomas R. Weinrich, Ups and

Downs of Audit Fees Since Sarbanes-Oxley Act, The

CPA Journal (October 2006) (reprinted at

www.nysscpa.org/printversians/cpaj/-

PE vnc ctcconccessccccccsecess 21

Jay M. Feinman, Liability of Accountants for Negligent

Auditing: Doctrine, Policy, and Ideology, 3\ FLA.

Fk FER TTT TTT TT ee 22, 23

Diana R. Franz, et al., The Impact of Litigation

Against an Audit Firm on the Market Value of

Nonlitigating Clients, 13 J. ACCT. AUDITING & Fin.

SP nchickend bnteheneenensestiecapess 25

Frederick L. Jones & K. Raghunandan, Client Risk

- and Recent Changes in the Market for Audit

Services, 17-J. AccT. & PuB. PoL’y 169 (1998). .... 21

Richard I. Miller & Michael R. Young,

Financial Reporting and Risk Management

in the 21st Century,

65 FORDHAM L. REV. 1987 (1997)............. 22, 23

Zoe-Vonna Palmorose, Who Got Sued? J.

OF ACCOUNTANCY ONLINE (March 1997),

available at www.aicpa.org/pubs/jofa/-

nc oc dveddeoctesecesacés 23

Vill

TABLE OF AUTHORITIES - cont’d

Page(s)

Jamie Pratt & James D. Stice, The Effects of Client

Characteristics on Auditor Litigation Risk Judgments,

Required Audit Evidence, and Recommended Fees,

BR ee 22

PricewaterhouseCoopers LLP, 2002 Securities

ccc kcdchncthegeenedseed sna’ 25

PricewaterhouseCoopers LLP, 2006 Securities

SPOUT ELT TOT EEL OE TLTTe ro

- Professionals Issues Task Practice Alert 2000-4,

Quality Review Procedures for Public Companies. .. 20

MICHAEL J. RAMOS, PRACTITIONER’S GUIDE

ee Oey oe 18, 19, 21

RESTATEMENT OF TORTS § 876..................-005- 3

SEC, Office of the Gen. Counsel, Report to the

President and the Congress on the First Year of

Practice Under the Private Securities Litigation

Reform Act of 1995 (Apr. 1997), available at

www.sec.gov/news/studies/Ireform.txt............. 24

INTEREST OF THE AMICUS CURIAE'

For more than 100 years, the American Institute of

Certified Public Accountants (“AICPA”) has served as the

national organization of the certified public accounting

profession. The AICPA’s nearly 340,000 members, all of

whom are certified public accountants, provide accounting

services to companies and individuals through firms of all sizes,

and as solo practitioners. Its members also serve as employees

of companies, and in the government and academia. Among the

AICPA’s most important roles is to promote and maintain high

professional standards among its members. To this end, the

AICPA has been a principal force in developing accounting and

auditing standards, drafting model legislation, sponsoring

educational programs, and issuing professional publications to

improve the quality of the services provided by CPAs.

The AICPA has a strong interest in judicial decisions that

affect the scope and bases of accountants’ liability under the

federal securities laws. Because they are seen as having “deep

pockets” and may be among the few solvent parties remaining

after a corporate collapse, CPAs provide attractive targets for

securities fraud plaintiffs. To ensure that accountants can focus

on serving clients rather than on defending against often

baseless lawsuits, the AICPA has participated as amicus curiae

in a wide variety of cases, including some of this Court’s most

significant securities fraud*cases in each of the last four

decades: Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127S. Ct.

2499 (2007); Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S.

336 (2005); Central Bank of Denver, N.A. v. First Interstate

Bank of Denver, N.A., 511 U.S. 164 (1994); Basic Jnc. v.

Levinson, 485 U.S. 224 (1988); and Ernst & Ernst v.

Hochfelder, 425 U.S. 185 (1976).

' The parties’ letters of consent to the filing of this brief have been

lodged with the Clerk. Pursuant to Rule 37.6 of the Rules of this

Court, the AICPA states that no counsel for a party has authored this

brief in whole or in part and that no person or entity, other than

amicus curiae, its members, or its counsel, has made a monetary

contribution to the preparation or submission of this bricf.

2

The Court’s decision in Central Bank, holding that there is °

no private right of action for aiding and abetting a violation of

Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.

§ 78)(b) and Rule 10b-5 promulgated thereunder, 17 C.F.R. §

240.10b-5, is of paramount importance to the accounting

profession. CPAs are paradigmatic “secondary actors,” who for

many years were sued under Section 10(b) not because they had

committed a manipulative or deceptive act, but on the theory

that they had assisted those who had. Central Bank put an end

to such private actions. Since then, however, the plaintiffs’

class action bar has tried to revive in several different guises the

very Claims that Central Bank held were unavailable. This case

is the culmination of that misbegotten project. Because it is of

manifest importance to the nation’s CPAs to preserve the

important limitations that Congress placed on Section 10(b) and

Rule 10b-5, the AICPA submits this amicus brief.

INTRODUCTION AND SUMMARY OF ARGUMENT

The existence of a private right of action for aiding and

abetting a violation of Section 10(b) was first recognized in

Brennan v. Midwestern United Life Ins. Co., 259 F. Supp. 673

(N.D. Ind. 1966), and quickly became an entrenched, albeit

unwarranted, staple of federal securities case law. Section 10(b)

aiding and abetting liability had both criminal and tort law

antecedents. See Alan R. Bromberg & Lewis D. Lowenfels,

Aiding and Abetting Securities Fraud: A Critical Examination,

52 ALB. L. REV. 637, 646-47 (1988). According to Learned

Hand’s influential formulation, criminal aiding and abetting

requires that the defendant must “in some sort associate himself

with the venture, that he participate in it as in something that he

wishes to bring about, that he seek by his action to make it

succeed.” United States v. Peoni, 100 F.2d 401, 402 (2d Cir.

1938); cf. Landy v. Fed. Deposit Ins. Corp., 486 F.2d 139, 163-

64 (3d Cir. 1973) (applying Peoni to Section 10(b)). Similarly,

the Restatement of Torts, cited by many courts in the pre-

Central Bank eta, states that a person is liable for the conduct of

another if he “knows that the other’s conduct constitutes a

breach of duty and gives substantial assistance or

3

encouragement to the other so to conduct himself.” Brennan,

259 F. Supp. at 680 (quoting RESTATEMENT OF TORTS § 876);

see Fed. Deposit Ins. Corp. v. First Interstate Bank of Des

Moines, N.A., 885 F.2d 423, 429-30 (8th Cir. 1989)..

From these sources, a common law of aiding and abetting

liability under Section 10(b) eventually took shape. As

generally articulated, such liability had three basic elements: (1)

a securities law violation by the primary violator; (2)

“knowledge” of this violation by the putative aider and abettor;

and (3) “substantial assistance” by the aider and abettor in

achieving the primary violation: Bromberg & Lowenfels,

supra, at 662. “Substantial assistance” could take many forms,

including aiding in the preparation of misstatements, financing

transactions, or executing transactions on behalf of the

principal. E.g., Cumis Ins. Society, Inc. v. E.F. Hutton & Co.,

457 F. Supp. 1380, 1386 (S.D.N.Y. 1978); see Bromberg &

Lowenfels, supra, at 701-39.

In 1994, this judge-made legal structure came crashing

down when this Court held that “the text of the 1934 Act does

not itself reach those who aid and abet a § 10/b) violation.”

Central Bank, 511 U.S. at 177. In so holding, the Court

recognized that some secondary actors — including those who

had knowingly participated in fraudulent activity — might escape

Section 10(b) liability. The Court nevertheless concluded that

its decision was compelled by the “text and structure” of Section

10(b). /d. at 188.

In the wake of Central Bank, Congress was persuaded by

the SEC to codify aiding and abetting in the Private Securities

Litigation Reform Act of 1995, Pub. L. No. 104-67, § 104, but

only for enforcement actions brought by the SEC itself. 15

U.S.C. § 78t(e). Like this Court, then, Congress made crystal

clear that those who merely assist others in defrauding investors

are not subject to private lawsuits under Section 1 0(b).

Central Bank \eft open the possibility that secondary actors

“may be liable as a primary violator under |0b-5, assuming a//

of the requirements for primary liability under Rule 10b-5 are

4

met.” 511 U.S..at 191 (emphasis in original). Seizing that

opening, the plaintiffs bar began to urge courts to liberalize the

requirements for primary liability in an effort to revive, in a

different guise, the very same aiding and abetting claims that

Central Bank had foreclosed.

The present case illustrates that effort. Whereas Central

Bank rejected as classic aiding and abetting such “secondary”

activities as participating, enabling, facilitating, and advising,

petitioner proposes to recharacterize the very same conduct as

a “deceptive device or contrivance” under Section 10(b), or as

either a “scheme to defraud” or as conduct “operat[ing] as a

fraud or deceit” under Rule 10b-5. Such conduct, petitioner

says, is a primary violation of the statute and the regulation (and

not merely aiding and abetting), so long as it is undertaken with

the “purpose and effect” of furthering the fraud.

These reformulations of ordinary aiding and abetting lack

any grounding in the text of Section 10(b). As this Court’s

cases have made clear, Section 10(b) forbids misstatements (but

only on the part of the person who actually makes the

misstatement), omissions (but only by those who have a duty to

disclose), and manipulative conduct (but only manipulations

that, standing alone, mislead the market about the value of a

security). Respondent is charged with none of these: It did not

make the misstatement that allegedly deceived petitioner

(Charter did so when it filed its financial statements); it did not

make an actionable omission (as it had no duty toward

petitioner); and its conduct was not a manipulation (since the

transactions in which respondent engaged had no impact on the

market unless and until Charter falsely accounted for them in its

financial statements).

Petitioner’s proposed reformulations are thus nothing but

aiding and abetting in new bottles. Nor is it true that

petitioner’s “purpose and effect”. test would separate true

“primary liability’ from mere aiding-and-abetting-style

“primary liability.” As we show below, that test is both

unworkable and unwise.

5

Finally, permitting private actions to revive aiding-and-

abetting liability under new labels would deter or raise the cost

of professional services that are of great importance to the

securities markets. When faced with the prospect of suit merely

for rendering assistance to a company that might itself defraud

investors, rational economic actors — such as certified public

accountants — may choose to sit on the sidelines. And because

of the enormous stakes of even modest-sized securities class

actions, the professionals who do provide those services and do

get sued will face “inordinate or hydraulic pressure” to settle

before trial, regardless of the merits. Newton v. Merrill Lynch,

Pierce, Fenner & Smith, Inc., 259 F.3d 154, 164 (3d Cir. 2001).

The costs dwarf the benefits and should not be tolerated.

The Court should affirm the Eighth Circuit’s decision.

ARGUMENT

I. WHERE -INVESTORS ARE INJURED BY AN

ISSUER’S FALSE FINANCIAL STATEMENTS,

LIABILITY UNDER SECTION 10(b) EXTENDS

ONLY TO THOSE PARTIES WHO ACTUALLY

MADE THE MISSTATEMENT

Most shareholder class actions follow a common pattern.

Investors allege that a company made a false statement

concerning the company’s financial condition, either in an

annual report, a quarterly report, or perhaps through a press

release or an interview with an executive. Frequently, the

plaintiffs sue the company’s auditor as well, alleging that the

auditor made a material misstatement in an audit report that

accompanied the company’s financial statements. Invoking the

fraud-on-the-market theory articulated in Basic Inc. v. Levinson,

485 U.S. 224 (1988), the plaintiffs argue that the misinformation

artificially inflated the stock price, and that they were injured

when the company’s true financial condition was revealed. The

plaintiffs seek damages under Section 10(b) for what they claim

they lost on account of the fraud.

6

This case is typical. Petitioner, purportedly acting on

behalf of all investors in the securities of Charter, alleges that

Charter’s public financial statements overstated the company’s

revenue and cash flow. Pet. Br. 3, 9. The false financial

statements, according to petitioner, inflated the price of

Charter’s stock. /d. at 3. And when Charter revealed the true

state of affairs and restated its financial statements, the market

price of its securities declined and Charter’s investors lost

money. /d. at 9.

What makes the case noteworthy is not its fact pattern, but

whom petitioner chose to sue. Not content to pursue the party

that issued the financial statements, petitioner sought other deep

pockets — specifically, two companies that entered into “phony”

and “sham” transactions (Pet. Br. 3, 7), to which petitioner

attributed part (but by no means all ) of the errors in Charter’s

financial statements. Although the respondents are not alleged

to have misstated their own financial statements — nor otherwise

communicated in any way with the market regarding the

transactions at issue — petitioners seek to hold them liable on the

ground that respondents’ participation in the underlying

transactions makes them primarily liable under Section 10(b)

for Charter’s alleged misstatements.

Petitioner’s argument contravenes the statutory text. If

accepted, it would also revive, in only slightly different garb,

the very liability theories rejected in Central Bank. For these

reasons alone, the court of appeals should be affirmed.

A. Allowing A Misstatement Case To Be

Recharacterized As A “Deceptive Conduct” Or

“Scheme” Case Is Inconsistent With The Text Of

Section 10(b) And With This Court’s Decisions

1. This Court has long held that, to engage in “deception”

under Section 10(b), one must make a “material

misrepresentation or material failure to disclose.” Santa Fe

Indus. v. Green, 430 U.S. 462, 474 (1977). And in Central

Bank, the Court squarely rejected the proposition that one can

>

be liable for a misrepresentation or failure to disclose merely by

engaging in conduct that aids and abets that deception.

Petitioner and its amici seek to evade these limiting

principles. Unhappy with the constraints imposed by the text of

Section 10(b), petitioner and its amici urge the Court to focus

instead on the text of Rule 10b-5. Pet. Br. 23-26; Brief of Amici

States of Arkansas, New Jersey, et al. (“Sts. Br.”) 2. Observing

that the Rule proscribes any “device, scheme or artifice to

defraud” (Rule 10b-5(a)), and any “act, practice, or course of

business which operates * * * as a fraud or deceit” (Rule 10b-

5(c)), petitioners contend that the Rule is broad enough to

encompass the “scheme” or “deceptive conduct” they allege

here after all. They argue that respondents’ “acts,” “schemes,”

and “practices” all violate the text of Rule 10b-5 — and thus

Section 10(b) as well — even though respondents did not make

the “material misrepresentation” (Charter’s financial statements)

that allegedly defrauded the market.

That attempt to leverage the language of Rule 10b-S5 into a

new private right of action fails, because it ignores the well-

established principle that the text of Section 10(b), rather than

that of the Rule, determines what conduct is prohibited. In

Central Bank, the Supreme Court reiterated that “the private

plaintiff may not bring a 10b-5 suit against a defendant for acts

not prohibited by the text of § 10(b).” S11 U.S. at 173.

Determining the scope of the Rule therefore requires “close

attention to the statutory text,” id. at 169 (emphasis added), for

“the language of the statute must control the interpretation of

the Rule.” Santa Fe Indus., 430 U.S. at 472. The statute

delimits the conduct proscribed, even if the Rule’s language is

susceptible of a more expansive interpretation. Ernst & Ernst

v. Hochfelder, 425 U.S. 185, 214 (1976). Accordingly, any

“scheme” or conduct “operat[ing] * * * as a fraud or deceit”

must fit within — not extend — the statutory language.

Section 10(b) says nothing about “schemes” or “practices,”

but instead makes it unlawful for any person “to use or employ,

in connection with the purchase or sale of any security * * * any

8

manipulative or deceptive device or contrivance * * *.” 15

U.S.C. § 78j(b). In Santa Fe Industries, the Court explained

that a plaintiff “states a cause of action under any part of Rule

10b-5 only if the conduct alleged can be fairly viewed as

‘manipulative or deceptive’ within the meaning of the statute.”

430 U.S. at 473-474 (emphases added). The Court then

addressed the meaning of both of these crucial terms.

“*Manipulation’ is ‘virtually a term of art when used in

connection with securities markets.’ The term refers generally

to practices, such as wash sales, matched orders, or rigged

prices, that are intended to mislead investors by artificially

affecting market activity.” /d. at 476 (quoting Hochfelder, 425

U.S. at 199). To be “manipulative” under Section 10(b), the

defendant’s conduct must “inject[] inaccurate information into

the market or create[] a false impression of market activity.”

GFL Advantage Fund, Lid. v. Colkitt, 272 F.3d 189, 205 (3d

Cir. 2001) (internal quotations omitted). In other words, the

manipulation must itse/f distort the market in a way that would

mislead investors.

As for “deception,” the Court in Santa Fe Industries held

that, because “the complaint failed to allege a material

misrepresentation or material failure to disclose,” there was no

allegation of “deceptive” conduct with the meaning of Section

10(b). 430 U.S. at 474. Accordingly, the deceptions proscribed

by the statute - and thus by Rule 10b-5 — involve the

dissemination of false information (or the failure to disseminate

truthful information in the face of a duty to do so). Central

Bank reaffirmed that basic understanding: “As in earlier cases

considering conduct prohibited by §10(b), we again conclude

that the statute prohibits only the making of a material

misstatement (or omission) or the commission of a manipulative

act.” 511 U.S. at 177.

Respondents’ alleged conduct in this case falls into neither

of those categories. Their actions plainly were not market

“manipulations” that “artificially affect{ed] market activity,”

and petitioner does not contend otherwise. Neither was their

9

alleged conduct a “deception,” because respondents did not

make the “material misrepresentation or material failure to

disclose” that petitioner contends defrauded the market. Santa

Fe Indus., 430 U.S. at 474, 476. According to petitioner, it was

Charter's financial statements that defrauded investors. See,

e.g., Pet. Br. 21 (Defendants’ conduct “cause[d] the publication

of artificially inflated financial statements to investors”), id. at

40 (“transactions were reflected in Charter’s financials”); Sts.

Br. 13 (“The plaintiffs in this action claim that they were

defrauded by Charter’s false reports of revenues and cash

flows.”).

Petitioner argues (Br. 31) that “conduct” — unaccompaniea

by either a misstatement or a failure of a duty to disclose — can

constitute a “deception” under the statute. But neither SEC v.

Zandford, 535 U.S. 813 (2002), nor United States v. O'Hagan,

521 U.S. 642 (1997), on which petitioner relies, support such a

broad proposition. In those cases, the defendant committed

deception by misappropriating funds (Zandford) or confidential

information (O 'Hagan), while fraudulently omitting to disclose

the act in breach of a fiduciary duty. \n both cases, the Court

made clear that it was the defendant’s “material failure to

disclose” that gave rise to liability for “deception.” See

O'Hagan, 521 U.S. at 660 (“deceptive nondisclosure is essential

to the § 10(b) liability at issue”; “it was O’Hagan’s failure to

disclose * * * that made his conduct ‘deceptive’ within the

meaning of § 10(b)”) (alterations omitted); Zandford, 535 U.S.

at 1906 n.4 (had Zandford merely “told his client he was

stealing the client’s assets * * * it would not [have] involve[d]

a deceptive device or fraud”).

This “failure to disclose” theory of deception is of no help

to petitioners. First and foremost, petitioners do not claim that

they were defrauded by respondents’ (or by anyone’s) non-

disclosure; they allege that they were defrauded by Charter’s

false financial statements. And in any event, as Zandford and

O'Hagan make clear, a failure to disclose a fraud may violate

the statute on/y when the failure breaches a fiduciary duty to

disclose. Notwithstanding the States’ argument (Sts. Br. 19-22),

10

mere “participation” in a fraud does not by itself give rise to a

freestanding duty to disclose the fraud to the public. If it did,

Central Bank would have come out the other way. See

Chiarella v. United States, 445 U.S. 222, 232-33 (1980)

(reversing insider trading conviction under Section 10(b)

because defendant was not party to an agency or other fiduciary

relationship that gave rise to a duty to disclose).

At bottom this is a simple misstatement case. Charter’s

allegedly misleading financial statements are paradigmatic false

statements actionable under Rule 10b-5(b). They are what the

market relied upon in overvaluing Charter securities, and thus

what petitioner relied on in deciding to invest. In contrast, the

revenue-generating transactions between Charter and

respondents merely “enabled” Charter’s alleged deception (Pet.

Br. 1) by helping to establish background conditions against

which the misstatements were made. By allegedly engaging in

conduct that did not itse/f deceive investors (but merely made

the issuer’s misstatements easier to prepare), respondents’ status

is (at most) that of aiders and abettors. To allow the claims

against respondents to proceed under a “scheme” theory would

resurrect the very kind of liability precluded by Central Bank

and would permit virtually anything that once constituted aiding

and abetting to become actionable by relabeling it as a

“scheme.”

2. Subjecting respondents to liability under Rule 10b-5(a)

or (c) would subvert not only the core holding of Central Bank,

but also the reasoning the Court used to get there. The Court

made clear that it was rejecting aiding and abetting liability in

order to implement Section 10(b)’s reliance requirement:

A plaintiff must show reliance on the defendant’s

misstatement or omission to recover under 10b-5. Were

we 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.

511 U.S. at 180 (internal citation omitted). The decision not to

read aiding and abetting liability into Section 10(b) thus sprung,

at least in part, from the Court’s unwillingness to allow a

defendant to be held liable without a showing that its own

actions induced the plaintiff to invest.

Yet the theory of liability propounded by petitioners and

their amici here would have precisely that effect. As the court

of appeals observed (Pet. App. 10a), petitioner purchased

Charter securities in reliance on the company’s alleged

misstatements — not in reliance on the allegedly “phony”

transactions in which respondents engaged. Allowing

petitioners to recover against those defendants would undermine

the bedrock requirement that reliance must be proven as to the

actions or statements of each defendant ~ individually.

_ Accordingly, petitioners’ notion (Pet. Br. 20) that a plaintiff

who relies on a misstatement thereby relies on the actions of

every party who played some antecedent role in helping that

misstatement come into life is precisely what Central Bank

rejected.

3. Section 10(b) makes it unlawful “[t]o use or employ” a

deceptive device or contrivance in connection with the purchase

or sale of a security. 15 U.S.C. § 78}(b) (emphasis added). To

“use” or “employ” a “deceptive device” means to “convert [it]

to one’s service,” or “to avail oneself of” it. Bailey v. United

States, 516 U.S. 137, 145 (1995). It follows that a party cannot

be liable under the statute on the basis of a deceptive device that

somebody else “convert[ed] to [his] service” or to which

somebody else “avail[ed}” himself.

According to petitioner’s own allegations, it was Charter’s

financial statements that misled investors. See, e.g., Pet. Br. 21.

And the only party that “used” or “employed” those financial

Statements was Charter itself, which published and filed them

with the SEC. There is no credible argument — nor do petitioner

or its amici so contend — that respondents “used” or “employed”

Charter’s financial statements.

12

Petitioner nevertheless urges that the inclusion of the word

“indirectly” in Section 10(b) (“It shall be unlawful for any

person, directly or indirectly, by the use of any means or

instrumentality of interstate commerce or of the mails * * * to

use or employ * * * any manipulative or deceptive device or

contrivance * * *”) means that “all those who engage in

deceptive conduct” may be liable under Section 10(b), even if

it is somebody else who defrauds the plaintiff. Pet. Br. 20. The

States refine the argument, contending that Section 10(b)

prohibits parties from “using another person as a ‘conduit’ i

communicate false information to the market.” Sts. Br. 22-29.

Even if the word “indirectly” modifies the phrase “use or

employ” (as opposed to modifying the statute’s jurisdictional

clause), it does not deliver the result petitioner and its amici

hope for. The cases cited in the States’ brief stand for the

unremarkable proposition that a defendant “cannot escape

liability simply because it carried out its alleged fraud through

the public statements of third parties.” Sts. Br. 23 (quoting

Cooper v. Pickett, 137 F.3d 616, 624 (9th Cir. 1997)). It is true,

of course, that a defendant who whispers his fraudulent

misinformation to a “conduit,” intending that the conduit will

disseminate the information about the defendant (and on his

behalf) is not insulated from Section !0(b) simply because he

used an intermediary.

But petitioner wants the word “indirectly” to extend

liability, as well, to someone who has at most facilitated

somebody e/se 's ability to make his own misstatement directly

to the public. Under those circumstances, the facilitator cannot

be said to have “indirectly” made a misstatement. To the

contrary, “{ajllegations of ‘assisting,’ ‘participating in,’

‘complicity in’ and similar synonyms * * * all fall within the

prohibitive bar of Central Bank.” Shapiro v. Cantor, 123 F.3d

717, 720 (2d Cir. 1997).

In this case, respondents did not enlist Charter to report

false information about respondents’ financial condition.

Charter’s financial statements did not disclose, for example, that

13

Charter had entered into an equipment-for-advertising deal with

respondents that would result in respondents earning a certain

amount of revenue. Charter’s financial statements did not even

mention the respondents, the transactions with respondents, or

any other information about respondents. It therefore cannot be

said that respondents were making a statement of any kind

through the issuance of Charter’s financial statements, whether

“directly” or “indirectly.” For the same reasons, auditors who

merely consult with clients regarding the structure or reporting

of transactions, are not liable under Section 10(b) — either

directly or indirectly — in the event the company makes a public

misstatement.

B. Petitioner’s “Purpose And Effect” Test Does Not

Successfully Distinguish Garden-Variety Aiding

And Abetting From True “Primary Liability”

In an effort not to revive a// classic aiding and abetting

claims, petitioner proposes to charge as primary liability only

conduct that is committed with the “purpose and effect” of

creating a false appearance of material fact in furtherance of a

scheme to defraud. The Ninth Circuit has already adopted a

similar standard, holding that a defendant may be held liable as

a primary violator under Section 10(b) if it engaged in conduct

that “had the principal purpose and éffect of creating a false

‘appearance of fact in furtherance of the scheme.” Simpson v.

AOL Time Warner Inc., 452 F.3d 1040, 1048 (9th Cir. 2006)

(emphasis added), petition for cert. filed subnom. Calif. St.

Teachers Ret. Sys. v. Homestore.com, Inc., 75 U.S.L.W. 3236

(U.S. Oct. 19, 2006) (No. 06-560).

The purpose and effect test utterly fails to distinguish

garden-variety aiding and abetting from primary liability. After

all, aiding and abetting presupposes that the secondary

participant had the same “purpose,” and caused the same

“effect,” as the primary violator. Indeed, under pre-Central

Bank case law, an alleged aider and abettor could be held liable

only if he acted with the purpose and effect of helping someone

else violate the securities laws. See Schatz v. Rosenberg, 943

14

F.2d 485, 496 (4th Cir. 1991) (aiding and abetting generally

requires a “conscious and specific motivation to aid the fraud”);

Renovitch v. Kaufman, 905 F.2d 1040, 1045-46 (7th Cir. 1990)

(internal quotation omitted); Edwards & Hanly v. Wells Fargo

Sec. Clearance Corp., 602 F.2d 478, 485 (2d Cir. 1979). And

this is hardly surprising, since aiding and abetting under Section

10(b) derived from accomplice liability under the criminal law,

under which the accomplice must have acted “with the .

knowledge and intention” of helping the principal commit the

crime. United States v. Sayetsitty, 107 F.3d 1405, 1411 (9th

Cir. 1997); see 1A Feb. JURY PRAC. AND INSTR. § 18.01 (Sth ed.

2000).

From the standpoint of investors in the securities markets,

moreover, a transaction whose purpose is the creation of false

revenues is entirely indistinguishable from one whose purpose

is not to do so. Investors are no more deceived by the former

than by the latter. In neither case can the transaction have any

effect on the market unless and until a third party decides to

record its proceeds in a misleading way. The purpose and effect

test thus misses the true distinction between primary liability

and aiding and abetting, which is that a primary defendant must

be culpable — in the Sense of actually defrauding investors or the

market — based on its own actions, rather than as a result of the

conduct or statements of someone else. The purpose of the

transaction (“primary” or otherwise) simply does not provide a

principled basis on which to distinguish actual violations of

Section 10(b) from mere aiding and abetting.

Finally, a “purpose and effect” test would be exceeding

difficult to apply: How do we know what the “purpose” of any

particular transaction is? One of the reasons that this Court

rejected aiding and abetting liability in Central Bank was that

“the rules for determining * * * liability are unclear, in ‘an area

that demands certainty and predictability.’"” 511 U.S. at 188,

quoting Pinter v. Dahl, 486 U.S. 622, 652 (1988). Such

uncertainty and unpredictability “leads 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

15

securities business.” J/bid., quoting Pinter, 486 U.S. at 652.

This Court concluded that “such a shifting and highly fact-

oriented disposition” was “not a satisfactory basis for a rule”

‘governing the standards for 10b-5 actions. /bid., quoting Blue

Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 755 (1975).

The “purpose and effect” test suffers from the same

deficiencies.

The Court should make clear that the “schemes” or

“deceptive conduct” covered by Rules |10b-S(a) and (c) are

those that of their own accord distort the market or deceive

investors. Conduct that does so only because another party uses

it to make a public misstatement is neither a manipulation nor

a deception under the statute.

ll. EXTENDING LIABILITY FOR’ FALSE

STATEMENTS TO PERSONS WHO DID NOT MAKE

THEM WOULD IMPAIR THE QUALITY OF

FINANCIAL REPORTING BY PUBLIC COMPANIES

Before an accounting firm issues a report on a public

company’s financial statements, it must perform an audit, the

elements of which are prescribed by an extensive body of rules

and regulations. Only after completing the required steps does

an auditor publicly attest to the sufficiency of the audit

procedures and the quality of the company’s financial

statements. Accounting firms are well aware that their

affirmative representations about the audits they perform and

about the quality of their audit clients’ financial statements ~ if

false - can give rise to crippling liability under the federal

securities laws. As a consequence, auditors have every

incentive to carry out a rigorous audit — typically an expensive

and laborious project ~ before affixing their firm’s name to the

audit report that accompanies the client’s audited financial

statements.

Under the “purpose and effect” test advocated by petitioner,

however, an auditor who conducts a limited review of a client’s

unaudited filings or public statements, or provides informal

advice about the structure of a pending transaction, is likely to

16

become a new target for class-action counsel carrying the

banner of “scheme liability.” And if auditors face the prospect

of bet-the-firm litigation based on a peripheral connection to

statements they have not made, and transactions they have not

audited, every auditor’s relationship with its public company

clients will be changed for the worse. The inherent murkiness

of a “purpose and effect” standard would make dismissal on the

pleadings of even meritless claims sufficiently uncertain as to

require auditors to raise the cost of such services, or even

decline to perform them altogether. All of that would make the

overall quality of financial reporting worse, not better.

The vagaries of Section 10(b) litigation are so great that the

regime petitioners propose may well cause auditors to “act in

ways that will avoid not simply conduct that the securities law

forbids * * * but also a wide range of * * * conduct that the

securities law permits or encourages.” Credit Suisse Securities

(USA) LLC v. Billing, 127 S. Ct. 2383, 2396 (2007).? Asa

result, rational auditors may conclude that the safest course is to

have nothing to do with any transaction or statement by a public

company that has not been subjected to a formal audit. And the

burden of that chilling effect would fall most heavily on the

smaller and newer companies, as well as those operating in

volatile industries such as technology, that have the greatest

need for the types of services most likely to be branded as

“schemes” by plaintiffs’ lawyers. The rule petitioners propose

would invite a new generation of claims that carry the threat of

limitless liability. The Court should not issue that invitation.

> See S. Rep. No. 104-98, at 9 (1995) (noting that “[uJnderwriters”

and “other professionals are prime targets of abusive securities

lawsuits” and that “[t}he deeper the pocket, the greater the likelihood

that a marginal party will be named as a defendant”).

17

A. The Open-Ended “Purpose And Effect” Test

Would Dissuade Auditors From Performing

Services That Are Beneficial To Public

Companies And Their Investors

1. The annua! financial statements that every public

company files with the SEC must be audited by a certified

public accountant. See .5 U.S.C. § 78j-! (mandating and

setting standards for annual audit). An “audit” is a term of art,

and its performance, from conception to completion, is

governed by an extensive body of detailed requirements. The

subject of the audit — the company’s annual financial statements

~ must be prepared by the company in accordance with an

equally detailed set of requirements. In most cases, after the

auditor completes the audit, it issues an audit report, in which

it makes two very specific public statements, one about the

audit, and one about the audited financial statements.

First (in the case of domestic public companies), the auditor

represents that the audit was conducted in accordance with the

standards of the Public Company Accounting Oversight Board

(“PCAOB”).’ Second, in the event an “unqualified” opinion is

warranted, the auditor represents that the audit provides a

“reasonable basis” on which to opine that the financial

statements “present fairly, in all material respects, the financial

position of [the] company,” and “the results of its operations

and its cash flows for the years then ended in conformity with”

Generally Accepted Accounting Principles (GAAP).

Courts have long held that both portions of the audit report

are “statements” for purposes of Section |0(b), and that either

statement, if knowingly false (and if all the other requirements

of Section 10(b) are satisfied), may be actionable in a private

securities action. See, e.g., Lattanzio v. Deloitte & Touche

LLP, 476 F.3d 147, 153 (2d Cir. 2007). Indeed, it is only

> The PCAOB has effectively adopted the Generally Accepted

Auditing Standards (sometimes known as GAAS) promulgated by the

AICPA.

18

through the act of issuing an opinion on the company’s financial

Statements that “the independent auditor assumes a public

responsibility transcending any employment relationship with

the client.” See United States v. Arthur Young & Co., 465 U.S.

805, 817 (1984) (emphasis in original). It is precisely because

of the practical and legal significance of the audit report that

audits of large public companies are typically such laborious

and expensive undertakings. Understandably, auditors are (and

should be) unwilling to affix their firm’s name to an audit report

without first having carried out the steps that the PCAOB

prescribes.

2. But a financial statement audit is not the only important

task that auditors perform for their public company clients.

Auditors commonly render a variety of other services that do

not require the planning and performance of a formal audit, and

that do not culminate in the issuance of a publicly filed

statement by the auditor.

For example, auditors typically perform a “review” of their

client’s quarterly, or interim, financial statements — a procedure

that is far more limited in scope than an audit of the annual

financial statements. See 17 C.F.R. § 210.10(d) (mandating

review); Statement on Auditing Standards (“SAS”) 100 (setting

out standards for review). Unlike an audit, a review is designed

for the limited purpose of communicating to the client whether

the auditor has become aware of any “material modifications”

that should be made to the financial statements in order to

comply with GAAP. D.R. CARMICHAEL, O. RAY WHITTINGTON

& LYNFORD GRAHAM, ACCOUNTANTS’ HANDBOOK, § 15.5(b)

(1 1th ed. 2007) (hereinafter “ACCOUNTANTS’ HANDBOOK”); see

also, MICHAEL J. RAMOS, PRACTITIONER’S GUIDE TO GAAS at

549 (2006) (hereinafter “PRACTITIONER’S GUIDE”).

Significantly, federal regulations are clear that an accountant is

not required to file a report with quarterly financial statements.

See 17 C.F.R. § 210.10(d).*

* Under the federal regulations, an auditor must issue a report only if

19

Since Central Bank, courts have consistently rejected

attempts by class action counsel to sue auditors on the basis of

alleged misstatements in their clients’ unaudited quarterly

filings. See Wright v. Ernst & Young LLP, 152 F.3d 169, 175

(2d Cir. 1998); Jn re IKON Office Solutions, Inc. Sec. Litig.,

131 F. Supp. 2d 680, 685 n.5 (E.D. Pa. 2001); /n re Kendall

Square Research Corp. Sec. Litig., 868 F. Supp 26, 28 (D.

Mass. 1994); /n re Seracare Life Sciences, Inc. Sec. Litig., No.

05-CV-2335-H (CAB), 2007 WL 935583, at *10 (S.D. Cal.

Mar. 19, 2007).

Under the expansive liability regime advocated by

petitioner, however, it would be a simple matter for inventive

plaintiffs’ counsel to extend Section 10(b) liability to auditors

on the basis of unaudited statements. First, counsel would

assert that the company fraudulently accounted for some

transaction in its quarterly financial statements. Next, counsel

would allege that the company’s auditor knowingly overlooked

or approved of the fraud during the quarterly review, all with

the “purpose and effect” of enabling the fraudulent “scheme.”

Experience teaches that the heightened pleading requirements

of the PSLRA would be cold comfort in the face of such claims;

if auditors were exposed to liability based on their clients’

unaudited financial statements, they would be well advised to

perform the procedures associated with an audit every quarter.”

the interim financial statements explicitly refer to the auditor’s review.

See 17 C.F.R. § 210.10(d). And, even when a report is filed in

connection with a quarterly financial statement, that report does not

give a positive assurance that the statements comply with GAAP, as

docs an audit opinion. Instead, the report provides only the negative

assurance that the auditor is not aware of any material modifications

that should be made to the financial statements. Sec PRACTITIONER'S

GUIDE at 563-64.

> The quarterly review function, though more limited in scope than an

audit, serves a valuable purposed. The review “is procedurally

integrated into the company’s year-end audit and thereby tends to

reduce sharp variations and year-end surprises by spreading

20

3. The expansive liability that petitioners propose also

would encourage plaintiffs’ counsel to sue auditors based on

contacts that are even less involved than a quarterly review.

Throughout the year, public companies consult with auditors to

discuss the accounting ramifications of various business

decisions. Auditors often attend meetings to discuss potential

transactions. Such interaction assists the client in understanding

how the transaction will affect its financial statements and helps

the client determine whether to do the transaction and how it

should be structured. Similarly, auditors often respond to

telephone inquiries from clients requesting advice on the

accounting treatment of proposed business decisions.

But if auditors may be subject to suit based on allegations

that even the briefest conversation was part of a scheme to

defraud, they may hesitate to interact with the client until the

performance of year-end audit procedures. This would be a

disservice to both the client and its shareholders. The client

may well refrain from entering into a transaction or making a

strategic business move if it does not have any guidance as to

the accounting implications of its decision. And, if the

company does take action but initially accounts for it

incorrectly, there will be larger corrections — or “year-end

surprises” (Lattanzio, 476 F.3d at 156) — in the annual financial

statements.

4. Finally, audit firms also provide advice to non-audit

clients. A company may seek a second opinion from an

accounting firm that is not its auditor on the accounting

treatment for a proposed transaction that raises novel or

undecided accounting issues. This kind of engagement, which

is recognized by the accounting literature,° allows issuers to

corrections throughout the year.” Lattanzio, 476 F.3d at 156 (citing

Professionals Issues Task Practice Alert 2000-4, Quality Review

Procedures for Public Companies).

* SAS 50, as amended by SAS 97, governs the issuance of letters

addressing proposcd transactions to non-audit clients.

21

consider numerous alternatives for reporting on new and

emerging issues. PRACTITIONER’S GUIDE at 494. Again,

however, adoption of “purpose and effect” scheme liability

would be seized upon by the plaintiffs’ bar as a basis for

alleging that the advice had the “purpose and effect” of

falsifying the company’s financial statements. In that world,

firms could be expected to refuse these engagements.

5. Once liability for deception under Section 10(b) is

untethered from any requirement that the defendant make a

public misstatement, there will be a chilling effect on the

performance by auditors of services that are beneficial to

companies and their shareholders. In the years immediately

preceding passage of the PSLRA, it was well documented that

rampant class action litigation against CPAs made accounting

firms increasingly unwilling to perform audits for clients

perceived as risky, such as those in financial distress, smaller or

less-well established companies (including start-ups), and

companies operating in volatile industries such as technology.

See Frederick L. Jones & K. Raghunandan, Client Risk and

Recent Changes in the Market for Audit Services, 17 J. ACCT.

& Pus. PoL’y 169, 179 (1998).

A shrinking supply forces companies with fewer resources

to absorb higher prices for legally required financial audits.’

Such high-risk firms are particularly dependent upon the

imprimatur of a well-established, well-respected auditor in

order to gain the confidence of the market. Depriving them of

quality auditing services makes it more difficult for the growth

sectors of the economy to develop to their full potential.

Central Bank, 511 U.S. at 189. For, even where litigation nsk

does not cause CPAs to forego providing professional services,

they will typically insist on higher fees to high-risk clients, |

” Audit fees for Fortune 500 companies increased by more than 100%

from 2001 to 2004. See Jack T. Ciesielski & Thomas R. Weinrich,

Ups and Downs of Audit Fees Since the Sarbanes-Oxley Act, THE

CPA JOURNAL (October 2006) (reprinted at www.nysscpa.org/-

printversions/cpaj/2006/1006/p28.htm).

22

costs that the client companies will undoubtedly attempt to pass

on to consumers. See Jamie Pratt & James D. Stice, The Effects

of Client Characteristics on Auditor Litigation Risk Judgments,

Required Audit Evidence, and Recommended Fees, 69 ACCT.

REV. 639, 655 (1994).

B. Auditors Are Especially Vulnerable To Vexatious

Securities Class Actions, And Thus Stand To Be

Disproportionately Harmed By The Rule Advocated

By Petitioner

Auditors are particularly attractive targets in securities class

actions for a number of reasons. First, application of the

conventions, rules, and procedures that collectively constitute

accepted accounting practices requires substantial professional

judgment. “[A ]uditing is not a mechanical process, and an audit

report is not an objective statement of fact.” Jay M. Feinman,

Liability of Accountants for Negligent Auditing: Doctrine,

Policy, and Ideology, 31 FLA. ST. U. L. REv. 17, 54 (2003).*

And, GAAP is not “a canonical set of rules that will ensure

identical accounting treatment of identical transactions,” but

instead “tolerate[s] a range of ‘reasonable’ treatments * * *.”

Thor Power Tool Co. v. Commissioner of Internal Revenue, 439

U.S. 522, 544 (1979).

An “expectations gap” therefore persists between what

CPAs expect of their work and what the public (and often the

courts) expect. See Richard I. Miller & Michael R. Young,

Financial Reporting and Risk Management in the 21st Century,

* An audit is designed to provide a reasonable basis for the auditor to

express an opinion on the client’s financial statements taken as a

whole. ACCOUNTANTS’ HANDBOOK § 15.5 at 16. (emphasis added).

An “audit does not guarantee that a client’s accounts and financial

Statements are correct any more than a sanguine medical diagnosis

guarantees well-being; indeed, even an audit conducted in strict

accordance with professional standards countenances some degree of

calibration for tolerable error which, on occasion, may result in a

failure to detect material omission or misstatement.” Jn re IKON

Office Solutions, Inc., 277 F.3d 658, 673 (3d Cir. 2002).

23

65 FORDHAM L. REv. 1987, 2016 & n.129 (1997). This gap

contributes to an environment in which investors are likely to

blame auditors for unforseen corporate collapses and to sue

them when they occur. The allegation that a CPA ran afoul of

some aspect of the general rules of GAAS or failed to identify

one of the myriad potential GAAP violations is easy to make

and difficult to rebut. Courts routinely invoke such alleged

violations in sustaining claims against auditors. See, e.g.,

Rhode Island Hosp. Trust Nat'l Bank v. Swartz, 455 F.2d 847,

852 (4th Cir. 1972); Jn re Ancor Communications, Inc., 22 F.

Supp. 2d 999, 1005-06 (D. Minn. 1998); /n re Miller Indus.,

Inc. Sec. Litig., 12 F. Supp. 2d 1323, 1332 (N.D. Ga. 1998).

Especially in a declining market, where the bursting of a bubble

leaves many investors with significant losses, bringing suit

against an auditing firm based on an allegedly deficient audit

can be an easy way to try to recoup those losses.

Second, CPAs are inviting, “deep pocket” targets for

expansive notions of securities fraud liability. In the wake of a

corporate failure, the auditor is often the last one standing. In

many cases, the issuer responsible for the allegedly misleading

financial statements has gone bankrupt or become otherwise

judgment-proof, leaving the CPA as the only entity from which

plaintiffs can hope to recover their investment losses. See

Daniel L. Brockett, Line Between Primary and Secondary

Liability Still Blurred in Securities Cases, 50 FED. LAW. 29, 30

(2003). Indeed, between 30 and 40 percent of.securities fraud

cases against auditors involve companies that are in, or about to

enter, bankruptcy. See Zoe-Vonna Palmorose, Who Got Sued?

J. oF ACCOUNTANCY ONLINE (March 1997), available at

www.aicpa.org/pubs/jofa/march97/whosued. htm. Thus, despite

having played only a secondary role — that may consist of little

morc than reviewing allegedly misleading financial statements,

or merely answering an accounting question on a quick phone

call — accounting firms frequently emerge as the lone defendant

financially able to satisfy a potential judgment. See Feinman,

31 FLA. St. U. L. REV. at 57.

24

Given their exposure to potentially vast liability, as well as

their concern for their professional reputations, accounting

firms may be forced to settle even where the merits of a suit are

dubious. Against this backdrop, confining “deception” liability

only to those defendants who actually made a deceptive

misstatement guards against the prospect that auditors will be

made to cover investment losses for which their actions were

not in fact responsible. Conversely, expanding Section 10(b)

liability in the manner petitioner suggests would move the

securities laws closer to what they were never intended to be: a

form of cost-free insurance for disappointed investors. See

Dura Pharmaceuticals, 544 U.S. at 344.

Failure to adhere to the statutory text — thereby opening the

door to a new wave of lawyer-driven litigation — would have

serious consequences for the already-beleaguered accounting

profession. Securities litigation is extremely costly, regardless

whether the underlying claim has the slightest merit. One study

found that it costs an auditor an average of $3.7 million to

defend itself against even a weak securities fraud class action.

See Palmrose, supra.

Class action litigation against accounting firms did decrease

in the first years after passage of the PSLRA, a trend

undoubtedly helped by this Court’s holding in Central Bank.

See SEC, Office of the Gen. Counsel, Report to the President

and the Congress on the First Year of Practice Under the

Private Securities Litigation Reform Act of 1995, at 22 (Apr.

1997), available at www.sec.gov/news/studies/lreform.txt.

More recently, however, there has been a resurgence in

litigation alleging accounting fraud and targeting CPAs. In

2006, accounting-related cases represented 60 percent of all

private securities class actions, up from 48 percent in 1996.

PricewaterhouseCoopers LLP, 2006 Securities Litigation

Survey, at 8-9. Accounting-related settlements represented the

majority of the largest securities fraud settlements, totaling 93

percent of all securities-related settlement amounts in 2006. /d.

at 31-33. It has thus been accurately observed that accounting

fraud seems to have become “the ‘complaint of choice’ for

25

private securities class action plaintiffs.” Pricewaterhouse-

Coopers LLP, 2002 Securities Litigation Survey, at 4.

Empirical studies have also shown that litigation against an

audit firm — even, or perhaps especially, frivolous ligation —

hurts the stock price of an auditor’s other clients. See Diana R.

Franz, et al., The Impact of Litigation Against an Audit Firm on

the Market Value of Nonlitigating Clients, 13 J. Acct.

AUDITING & Fin. 117 (1998).

Finally, the expansive — and non-textual — construction of

Section 10(b) advocated by petitioner is all cost and no benefit:

There is simply no reason to fear that rejecting “purpose and

effect” liability will somehow create a gap in the enforcement

of the securities laws. The SEC is authorized to bring

enforcement actions against aiders-and-abettors. See 15 U.S.C.

§ 78t(e). The federal government thus always retains the power

to take action against individuals and firms that knowingly and

substantially assist fraud proscribed by the federal securities

statutes, regardless of whether any particular investors suffered

financial harm as a result of that fraud. There is neither need

nor reason to extend that expansive law enforcement power to

private plaintiffs. To the contrary, doing so could effectively

delegate wide-ranging enforcement power to unaccountable ~

plaintiffs’ lawyers, trenching on the SEC’s prosecutorial

discretion.

The States miss the mark when they argue (at 8) that private

litigation is necessary to supplement SEC enforcement actions.

Although it has been noted that, in certain circumstances,

private lawsuits serve a valuable role, Congress was explicitly

asked to reverse Central Bank with regard to both private

plaintiffs and the SEC. See S. Rep. No. 104-98, at 48-49

(1995). Congress elected to restore such liability on/y when the

SEC is the plaintiff. See 15 U.S.C. § 78t(e). Petitioner should

not be permitted to circumvent Congress’ judgment by slapping

a new name on aiding and abetting cases.

26

CONCLUSION

For the foregoing reasons, the judgment of the Eighth

Circuit should be affirmed.

Respectfully submitted.

RICHARD I. MILLER LAWRENCE S. ROBBINS*

American Institute of GARY A. ORSECK

Certified Public Accountants KATHRYN S. ZECCA

121] Avenue of the Robbins, Russell, Englert,

Americas Orseck & Untereiner LLP

New York, NY 10036 1801 K Street, N.W.

(212) 596-6200 Suite 411

Washington, D.C. 20006

(202) 775-4500

* Counsel of Record

Counsel for Amicus Curiae

American Institute of Certified Public Accountants

AuGustT 2007