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

pth O33 (© FILED

43PP No. 06-43 JUN 1 4 2007

OFFICE OF THE CLERK

ees SUPREME COURT, U.S._|

Supreme Court of the United States

STONERIDGE INVESTMENT PARTNERS, LLC,

Petitioner,

v.

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

Respondents.

On Wait oF CERTIORARI TO THE

UnitepD STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

——_——-

——=—

Brief FOR Amici CuriAE STATES OF ARKANSAS, NEW JERSEY,

RHOpE ISLAND, AND THE NEW YORK STATE COMMON RETIREMENT

FUND, PENNSYLVANIA PuBLic SCHOOL EMPLOYEES’ RETIREMENT

SYSTEM, PENNSYLVANIA STATE EMPLOYEES’ RETIREMENT SYSTEM,

AND THE MUNICIPAL EMPLOYEES’ RETIREMENT SYSTEM OF

MICHIGAN IN SupPORT OF PETITIONER

STANLEY D. BERNSTEIN

Counsel of Record

WILLIAM A.K. TITELMAN

CurISTIAN P. SieBort

ANN M. LIPTON

BERNSTEIN LIEBHARD & LirsHitz, LLP

10 East 40" Street

New York, New York 1€916

(212) 779-1414

Counsel for Amici Curiae

(Additional Counsel listed on signature page) P

eee

i

TABLE OF CONTENTS

Page

TABLE OF CITED AUTHORITIES ............ iii

INTEREST OF AMICUS CURIAE ............. l

SUMMARY OF ARGUMENT ................. 2

ARGUMENT

I. MODERN COMPLEX FRAUDS RELY ON

THE PARTICIPATION OF MULTIPLE

EE Bek caidee dana hvac heawieeeeeen 4

Il. SECTION 10(b) FORBIDS PARTICIPATION

IN TRANSACTIONS INTENTIONALLY

DESIGNED TO ENABLE FRAUD ....... 8

A. Central Bank and its History ......... 8

B. The Eighth Circuit’s Overly Narrow

Interpretation of Section 10(b) Should be

RE deS inthe ki nenenaweeees<s 1]

i. Section 10(b) Forbids All Forms of

Manipulative and Deceptive

BREE cAnbondeudvanbacsedees 12

ii. Participation in Fraudulent Conduct

Triggers a Duty to Disclose ...... 19

ii

Contents

Page

iii. Section 10(b) Forbids Entities from

Using Others as Conduits to

Distribute False Information to the

ae os ie Oe ee 22

ED oct vecducddtuneeetaceveneeses 29

ili

TABLE OF CITED AUTHORITIES

Page

Cases:

A. T. Brod & Co. v. Perlow,

SPD Vell FOS GH Ge BOUED oo vcecccecccccccce 12

Atchison, Topeka & Santa Fe Railway Co.

nw Commoeme, 203 U.S. 1 C1SGS) .. wc ccc ccc ccee 29

Backman v. Polaroid Corp.,

ge Ele le | re 19

Barker v. Henderson, Franklin, Starnes & Holt,

Fe Cede SET Gs CPD ccc ccevcecseves Y

Basic Inc. v. Levinson,

i es ek Shee Ga ehee #6 17,18

Caiola v. Citibank, N.A.,

ee ED obs ccccecasweses 19

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

Pee es ED nb ket wetdnseccceseses passim

In re Charter Communications, Inc., Securities

Litigation, 443 F.3d 987 (8th Cir. 2006) ...... passim

Chiarella v. United States,

Ee EE od no eve ens ss cde ee soe passim

iv

Cited Authorities

Cooper v. Pickett,

137 F.3d 616 (9th Cir. 1997) ........

DBLKM, Inc. v. Resolution Trust Corp.,

969 F.2d 905 (10th Cir. 1992) .......

Dirks v. SEC,

GRP UW. GOD GIFSS) ccc ncccccccces

Elkind v. Liggett & Myers, Inc.,

635 F.2d 156 (2d Cir. 1980) ........

Ernst & Ernst v. Hochfelder,

ee GPA OP ETUTED kee scctcocsccss

Fidel v. Farley,

392 F.3d 220 (6th Cir. 2004) ........

First Interstate Bank, N.A. v. Pring,

969 F.2d 891 (10th Cir. 1992) .......

Harmsen v. Smith,

693 F.2d 932 (9th Cir. 1982) ........

Helwig v. Vencor, Inc.,

251 F.3d 540 (6th Cir. 2001) ........

Herman & MacLean v. Huddleston,

Se a PEGE cc ccrnceseecves

Vv

Cited Authorities

Page

Marshall v. Perez Arzuaga,

Ge Th ie Bs rrr 29

Mertens v. Hewitt Associates,

Pe ED oc he 46 6.0 5 0-0 kebeeee ewan 28

Metge v. Baehler,

pg fd Le | 9

Mosser v. Darrow,

re oe! 28

In re Navarre Corp. Securities Litigation,

BoP Uae FEO GE Gs GED ove ce cn eeckcehes 23

Oran v. Stafford,

Be Oe 2Te COG: BOD occ vcvcccccsswuce 19

Overton v. Todman & Co., CPAs, P-C.,

i Se ge le ee err ree 19

In re Parmalat Sec. Litigation,

376 F. Supp. 2d 472 (S.D.N.Y. 2005) ......... 8,9

Regents of University of California

v. Credit Suisse First Boston (USA), Inc.,

482 F.3d 372 (Sth Cir. 2007) ........... 4,7, 14, 16

Rombach v. Chang,

po ee le ee ee ee ee 23

vi

Cited Authorities

Page

Rudolph y. Arthur Andersen,

800 F.2d 1040 (11th Cir. 1986) .......... 20, 21, 22

Santa Fe Industries v. Green,

ccc occ edsyéecncse vases 14, 16

Schreiber v. Burlington Northern, Inc..,

Te de eee eRe ee eeaeeepe ses 14

SEC v. Franco,

253 F. Supp. 2d 720 (S.D.N.Y. 2003) .......... 20

SEC v. Warde,

a BOOED cc cccesceccceceses 20

SEC v. Zandford,

i oi con geeereeneeesesene 2,14

Shapiro v. Cantor,

SP a PEE GEG CODED cis cccccccccesece 8

Shapiro v. Merrill Lynch, Pierce, Fenner & Smith,

Inc., 495 F.2d 228 (2d Cir. 1974) ............. 19

Simpson v. AOL Time Warner Inc.,

452 F.3d 1040 (9th Cir. 2006) ............ 4, 13,18

Southland Securities Comp. v. INSpire Insurance

Solutions, Inc., 365 F.3d 353 (Sth Cir. 2004) .... 23

vil

Cited Authorities

Page

Superintendent of Insurance

v. Bankers Life & Casualty Co.,

cee adc ckeckucedenesuseuses 12

United States v. O’ Hagan,

ee oe a eee eC bahee eens 14

Warshaw v. Xoma Corp.,

Oe Fee Fe Ce Gee BRD once c ccc cccsccecs 23

Weiss v. S.E.C., 468 F.3d 849 (D.C. Cir. 2006) .... 27

Whitehead v. Food Max of Mississippi, Inc.,

163 F.3d 265 (Sth Cir. 1998) ................ 29

Wright v. Ernst & Young LLP,

152 F.3d 169 (2d Cir. 1998) ................ 25, 27

Ziemba v. Cascade International, Inc..,

256 F.3d 1194 (11th Cir. 2001) .............. 20

Statutes, Regulations, and Rules:

ME. sceeddenechsdnud ueeetmnasns 26

TT Gudnewls 64066u650bn6beneeeeas 6

17 C.FR. § 240.10b-5 2... eee ee eee 2

vill

Cited Authorities

Legislative Materials:

H.R. Conf. Rep. No. 369, 104th Cong., Ist Sess. 31

Dd: videsdbd Cute beeehRCeeunad oes

1 The Role of Financial Institutions in Enron’s

Collapse: Hearings before the Permanent

Subcomm. Of Investigations of the Senate

Governmental Affairs Committee, 107th Cong.

Di iaiviceriiusnedeatabessontseusahe<

S. Rep. No. 792, 73d Cong., 2d Sess. (1934) ......

Other Authorities:

Paul Beckett and Jathon Sapsford, Citxgroup’s Vast

Reach Brings It Trouble From Many Quarters,

eee

Dennis K. Berman, Julia Angwin and Chip

Cummins, Tricks of the Trade: As Market Bubble

Neared End, Bogus Swaps Provided a Lift, Wall

FR 8) eer eer

John C. Coffee, Understanding Enron: “It's About

the Gatekeepers, Stupid,” 57 Bus. Law. 1403

IS « «mney beh bape ews 6-46 Vebs wtp heed

Gretchem Morgenson, S. F.C. Wants a Monitor to

Examiine A.|G. s Books, N.Y. Times,

EE ae Pee

Page

ix

Cited Authorities

Page

Restatement (First) of Torts ................... 24

Restatement (Second) of Torts ................ 21, 25

United States as Amicus Curiae Supporting

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

No. 06-484 (Feb. 9, 2007) ..... cc ccc ccccces 8

Webster’s New International Dictionary (2d ed.

be odndhtwdddwed wie Ghbensades benkeae 15

pe =) ‘ &

: eS ey se ee eee ae ee ee eae Oe? eS a

I

INTEREST OF AMICUS CURIAE!

The Amici States, as guardians of the citizenry, have a

paramount interest in the enforcement and proper interpretation

of the securities laws. The States give recognition to and confer

both rights and responsibilities on corporations. Thus, the reach

of the federal securities laws, and the scope of conduct covered

by those laws, are of great concern to the States and their citizens.

The Amici public pension funds, as fiduciaries to the public

employees who rely on them to prudently manage their

retirement funds, are among the largest institutional investors,

public or private, in the United States, and have a special

responsibility to help insure the transparency of the capital

markets and the accountability of their participants.

Together, the Amici States and the Amici public pension

funds manage an aggregate $360 billion invested in the public

markets. Combined, they manage the retirement plans for over

over 2.7 million active and retired public servants. Increasingly,

the Amici States and Amici public pension funds act as lead

plaintiffs in securities class actions, and in the aggregate

currently serve as lead plaintiffs in 14 pending securities class

actions. As lead plaintiffs, Amici play a pivotal role in enforcing

and deterring violations of the securities laws and in recovering

losses for investors and pensioners victimized by fraud. As large

public institutional investors, Amici are especially effective lead

plaintiffs, just as Congress contemplated when it devised the

lead plaintiff provisions of the Private Securities Litigation

' Pursuant to this Court's Rule 37.6, Amici state that no counse!

for any party authored this brief im whole or in part, and no person or

entity other than amicusscuriae, its members, or its counsel, has made a

monetary contribution to the preparation or submission of brief. Pursuant

to Rule 37.3, the parties’ letters of consent to the filing of this brief

have been lodged with the Clerk

2

Reform Act of 1995, and as courts have consistently recognized

since.

The Court’s decision in this case will greatly impact the

Amici States’ ability to fulfill their roles as protectors of the

public interest, and the Amici public pension funds’ ability to

fulfill their roles as fiduciaries of publicly managed funds.

SUMMARY OF ARGUMENT

The Securities Exchange Act of 1934 forbids “any person

... [t]o use or employ, in connection with the purchase or sale

of any security ... any manupulative or deceptive device or

contrivance in contravention of such rules and regulations as

the [Securities amd xchange] Commission may prescribe. . . .”

15 U.S.C. §78j(b)’ By its terms, the statute places no limits on

the persons who can be liable or on the types of “manipulative

or deceptive devices or contrivances” that are prohibited. Thus,

> The Securities and Exchange Commission (“SEC”) has

promulgated Rule |0b-5, 17 C.F.R. § 240.10b-5, which prohibits

any person, directly or indirectly ... (a) To employ any

device, scheme, or artifice to defraud, (b) To make any

untrue statement of a material fact or to omit to state a

material fact necessary in order to make the statements

made, in light of the circumstances under which they were

made, not misleading, or (c) To engage in any act, practice,

or course of business which operates or would operate as

a fraud or deceit upon any person, in connection with the

purchase or sale of any security.

The decision below did not address the scope of the rule, which has

been held to be “coextensive with the coverage of § 10(b),” SEC v.

Zandford, 535 U.S. 813, 816 n.1 (2002), but instead analyzed only

whether the alleged conduct could be considered manipulative or

deceptive under the statute, see In re Charter Communications, Inc.,

Securities Litigation, 443 F.3d 987, 992-93 (8th Cir. 2006).

3

under any reading, this language must forbid persons or entities

from structuring transactions in a manner that has no legitimate

business purpose other than to permit the creation of false

financial statements for public distribution.

Disregarding the statute’s text, the Eighth Circuit in Jn re

Charter Communications, Inc., Securities Litigation, 443 F.3d

987 (8th Cir. 2006), concluded that nothing in Section 10(b)

forbids third-party entities from intentionally engaging in sham

transactions for the purpose of having those transactions falsely

reported to the investing public by their business partners. The

court reached this surprising conclusion in three steps, each of

which was error.

First, the court erred by adopting a constricted reading of

the statute to forbid only the making of false statements (or

misleading omissions) and manipulative trading practices.

However, as this Court has previously made clear, the statute

forbids all forms of deceptive conduct that are intended to falsely

affect the price of a security. When the fraud is ultimately

consummated through the issuance of a false financial statement,

as occurred in this case, the statute prohibits any acts that caused

the statement to issue, so long as those actions are “deceptive.”

Because sham contracts, wash transactions, and the like are

“deceptive” under any definition of that term, and because — as

alleged here — such transactions were necessary to the fraud’s

consummation, liability should lie under Section 10(b).

The Eighth Circuit’s next error was to conclude that liability

will lie for an omission only if the actor operates under a

preexisting fiduciary duty of disclosure. Because. in the Eighth

Circuit’s view, outside entities that do business with fraudsters

operate under no such duty, the court concluded that the vendor-

defendants could not be held liable for failing to disclose the

false financial reporting. The Eighth Circuit thus failed to

4

recognize that both this Court and others have repeatedly

emphasized that one who intentionally participates in another’s

breach of fiduciary duty inherits the same duties of disclosure

as the original fiduciary — and is equally liable for a failure to

disclose material information. Because the vendors in this case

intentionally participated in just such a breach by purposefully

providing Charter’s corporate officers with information intended

to be falsely reported to the investing public, the vendors were

subject to a duty of disclosure. They can thus be held liable for

remaining silent in the face of Charter’s fraud.

Finally, the Eighth Circuit reasoned that, despite the vendor-

defendants’ purposeful injection of false information into the

market, the vendors had not made, nor caused to be made, any

false statements. However, every circuit to consider the issue

has agreed that Section 10(b) not only forbids persons from

personally making false statements, but also forbids persons

from channeling false information to the market through

intermediaries and third parties. In this case, the vendors

intentionally provided false information to Charter for the

purpose of having Charter distribute that information to the

public in its financial statements. The vendors may thus be held

liable for the damages caused by that false information.

ARGUMENT

Il. MODERN COMPLEX FRAUDS RELY ON THE

PARTICIPATION OF MULTIPLE ACTORS

It is no coincidence that certiorari petitions in Charter

Communications, Regents of University of California v. Credit

Suisse First Boston (USA), Inc. (“Credit Suisse”), 482 F.3d 372

(Sth Cir. 2007), and Simpson v. AOL Time Warner Inc., 452

F.3d 1040 (9th Cir. 2006), came before this Court at roughly

the same time. These actions, with facts that, as the Fifth Circuit

observed, are “extraordinarily similar,” Credit Suisse, 482 F.3d

5

at 388, are emblematic of the sophisticated forms of accounting

fraud that have been at the center of a wave of scandals dating

from the late 1990s. These scandals, which have resulted in the

spectacular implosions of some of Wall Street’s biggest names,

have had one thing in common: the degree to which the fraud

could never have been accomplished but for the active,

intentional, and purposeful participation of third parties —

auditors, bankers, insurers, and business partners.

The extent to which these frauds have depended on the

participation of outside entities has by now been well

documented. Not only did these outside entities engage in

transactions designed for the sole purpose of hiding their clients’

debt and (falsely) increasing clients’ reported revenues and cash

flow, but, in many cases, auditors, insurers, and investment

bankers specifically designed new fraudulent structures and

openly marketed them to their clients. For instance, Robert

Roach, Chief Investigator for the Senate Permanent

Subcommittee on Investigations, testified before Congress that

a number of financial institutions intentionally sold fraudulent,

Enron-style accounting structures known as “prepays” to their

other clients:

[JP Morgan] Chase developed a “pitch book” to sell

other companies on Enron-style prepays. The

presentation describes the transactions as “Balance

sheet ‘friendly’.” It also sets out in general terms

Chase’s use of its special purpose entity, Mahonia,

in structuring the trades and clearly explains that the

trades are orchestrated to work together. This

explanation of the deliberate packaging of the trades

flatly contradicts claims that the trades are

independent and unrelated. Chase apparently entered

into Enron-style prepays with seven companies apart

from Enron.

6

Citigroup also developed a presentation to sell

companies on Enron-style prepays, promoting, in

particular, the Yosemite structure it had developed

... Citigroup shopped this Enron-style prepay to 14

companies, successfully selling it to at least three.”

1 The Role of Financial Institutions in Enron’s Collapse:

Hearings before the Permanent Subcomm. Of Investigations of

the Senate Governmental Affairs Committee, 107th Cong.

(2002) (statement of Robert L. Roach, Chief Investigator,

Permanent Subcomm. on Investigations). The accounting firm

of Arthur Andersen developed a “white paper” that it distributed

to telecommunications companies, explaining how to avoid

certain accounting standards in order to create fictitious revenue.

See Dennis K. Berman, Julia Angwin and Chip Cummins, Tricks

of the Trade: As Market Bubble Neared End, Bogus Swaps

Provided a Lift, Wall St. J., Dec. 23, 2002, at Al. And in 2003,

the insurance company A.I.G. paid $10 million to settle the

SEC’s charge that it had “played an indispensable part” in the

fraud at a company called Brightpoint by selling it an insurance

product “that A.I.G. had developed and marketed for the specific

purpose of helping issuers to report false financial information

to the public.” Gretchen Morgenson, S. E.C. Wants a Monitor to

Examine A.LG.’s Books, N.Y. Times, Nov. 3, 2004, at C1.

Under any ordinary reading of the Securities Exchange Act

of 1934 (“Exchange Act”), this would seem to be precisely the

kind of conduct forbidden by the statute. Section 10(b),

15 U.S.C. § 78j(b), makes it unlawful for any person “directly

or indirectly ... to use or employ, in connection with the

purchase or sale of any security ... any manipulative or

deceptive device or contrivance in contravention of such rules

and regulations as the [SEC] may prescribe.” The Exchange

Act was passed in the aftermath of the 1929 market crash, and,

in addition to outlawing a number of specific manipulative

7

practices, included Section 10(b) as a “catch-all” provision to

prohibit “any other cunning devices” that were not identified

elsewhere in the statute or that might be developed after the

statute’s passage. Ernst & Ernst v. Hochfelder, 425 U.S. 185,

202-03 (1976) (quoting legislative history). The statute was

explicitly intended to address the fact that some fraudulent

conduct takes place “behind the scenes”: not only does it ban

use of manipulative devices both “directly” and “indirectly,”

but, as this Court acknowledged, the statute applies equally to

issuers and to lawyers, banks, and accountants, for “[iJn any

complex securities fraud, [] there are likely to be multiple

violators.” Central Bank, N.A. v. First Interstate Bank, N.A.,

511 U.S. 164, 191 (1994).

But despite whet would appear to be the plain language of

the statute and the obvious intention of Congress to ban precisely

this sort of behavior — which, as alleged in this action, involves

planned, premeditated, and coordinated market manipulation —

the Eighth Circuit in Charter, followed by the Fifth Circuit in

Credit Suisse, determined that when an outside entity

intentionally engages in transactions for the purpose, and with

the effect, of having those transactions falsely reported to the

market through the financial statements of clients and customers,

such conduct is neither “manipulative” nor “deceptive.” See

Charter, 443 F.3d at 992-93; Credit Suisse, 482 F.3d at 387-90.

Rather, both courts concluded that such conduct can be no more

than “aiding and abetting” — conduct that, per this Court’s

decision in Central Bank, is not prohibited by the text of Section

10(b). Central Bank, 511 U.S. at 177-78.

If permitted to stand, these decisions provide a road map

for committing fraud, and represent a true threat to the integrity

of the securities markets. As Professor Coffee has observed,

third party “gatekeepers” play a critical role in keeping

corporations honest. See John C. Coffee, Understanding Enron:

8

“It's About the Gatekeepers, Stupid,” 57 Bus. Law. 1403 (2002).

These gatekeepers may be more responsive to the threat of

liability than their clients, for they depend on reputational capital

to maintain their businesses, see, e.g., Paul Beckett and Jathon

Sapsford, Citigroup's Vast Reach Brings It Trouble From Many

Quarters, Wall St. J., July 26, 2002, at Al, and they do not reap

the immediate “benefits” of fraud through increases in their own

stock prices. Insulating gatekeepers from liability for the costs

of their misconduct will encourage future frauds. Nor can it be

said that governmental enforcement actions will provide all

required deterrence; as Congress has explained, “[P]rivate

lawsuits promote public and global confidence in our capital

markets and help to deter wrongdoing and to guarantee that

corporate officers, auditors, directors, lawyers and others

properly perform their jobs.” H.R. Conf. Rep. No. 369, 104th

Cong., Ist Sess. 31, at 31 (1995); see also Brief for the United

States as Amicus Curiae Supporting Petitioners at 1, Jellabs

Inc. v. Makor Issues & Rights, No. 06-484 (Feb. 9, 2007)

(“({Mleritorious private actions are an essential supplement to

criminal prosecutions and civil enforcements.”).

Il. SECTION 10(B) FORBIDS PARTICIPATION IN

TRANSACTIONS INTENTIONALLY DESIGNED

TO ENABLE FRAUD

A. Central Bank and its History

Prior to this Court’s decision in Central Bank, it was

generally accepted among the circuits that liability would lie

for aiding and abetting violations of Section 10(b). Because the

penalties for aiding and abetting were often similar to those for

primary violations, courts rarely distinguished between the two

types of liability. See In re Parmalat Sec. Litig. , 376 F. Supp. 2d

472, 494 (S.D.N.Y. 2005); see also Shapiro v. Cantor, 123 F.3d

717, 720 n.2 (2d Cir. 1997). Frequently, courts characterized

9

any conduct by a secondary actor, such as an outside auditor, as

“aiding and abetting,” even when the actor directly issued false

statements under its own name — conduct that today would be

easily recognized as sufficient to incur primary liability.

See Parmalat, 376 F. Supp. 2d at 495 (discussing cases).

Courts also differed as to how “aiding and abetting” was

defined. For instance, in Harmsen v. Smith, 693 F.2d 932 (9th

Cir. 1982), the Ninth Circuit listed the elements of aiding and

abetting as “(1) the existence of an independent primary wrong;

(2) actual knowledge by the alleged aider and abettor of the

wrong and of his or her role in furthering it; and (3) substantial

assistance in the wrong.” /d. at 943. In DBLKM, Inc. v.

Resolution Trust Corp., 969 F.2d 905 (10th Cir. 1992), the Tenth

Circuit held that recklessness would satisfy the scienter element

of an aiding and abetting claim. See id. at 909. And in Barker v.

Henderson, Franklin, Starnes & Holt, 797 F.2d 490 (7th Cir.

1986), the Seventh Circuit required that the alleged aider and

abetter have “committed one of the ‘manipulative or deceptive’

acts or otherwise met the standards of direct liability.” Jd. at

495. That court distinguished its aiding and abetting test from

primary liability by requiring that the primary violator “offer or

sell the securities.” /d.’ In many circuits, the scienter requirement

for aiding and abetting liability varied with the degree of

assistance the alleged aider had provided the primary violator;

the more substantial the assistance, the lower the scienter

requirement. See Metge v. Baehler, 762 F.2d 621, 624-25 (8th

Cir. 1985). Thus, at the time Central Bank was decided, the

boundary between “primary” and “secondary” liability was, at

best, fluid.

In Central Bank, this Court for the first time held that

Section 10(b) does not impose liability on those “who do not

* This Court has since made clear that no such requirement exists

for primary liability to attach. See Central Bank, 511 U.S. at 191.

10

engage in the manipulative or deceptive practice, but who aid

and abet the violation.” 511 U.S. at 166-67. Reasoning that “the

statutory text controls the definition of conduct covered by

§ 10(b),” id. at 175, this Court held that aiding and abetting was

not covered by the statute because the statutory text limited its

prohibitions to “manipulative or deceptive acts in connection

with the purchase or sale of securities.,” id. at 173.

Critically, however, for the purpose of its analysis, the Court

employed the following definition of aiding and abetting:

“(1) a primary violation of § 10(b); (2) recklessness by the aider

and abettor as to the existence of the primary violation; and (3)

substantial assistance given to the primary violator by the aider

and abettor.” Jd. at 168; see also id. at 190 (emphasizing that

“recklessness, not intentional wrongdoing, is the theory

underlying the aiding and abetting allegations in the case before

us”). The Court did not address the various permutations of

aiding and abetting liability that had been applied in the lower

courts and, because the plaintiff in Central Bank had not charged

the defendant with primary liability, the Court was not called

upon to distinguish reckless substantial assistance to a primary

violator from prohibited conduct “involving manipulation or

deception.” The Central Bank Court thus did not undertake an

analysis of what sorts of “acts” might qualify as “manipulative

or deceptive” under the statute. As a practical matter, the Court

held only that liability under Section 10(b) requires manipulative

or deceptive conduct, and that the formulation of reckless

substantial assistance was overly broad, “extend[ing] beyond

persons who engage, even indirectly, in a proscribed activity

.. . but who give a degree of aid to those who do.” 511 U.S. at

176.

Notwithstanding Central Bank’s clear directive that “the

statutory text controls the definition of conduct covered by

§ 10(b),” 511 U.S. at 175, the Eighth Circuit nonetheless

1]

determined that conduct unquestionably deceptive under any

ordinary meaning of the word — the creation of sham contracts

and wash transactions with no economic substance — is not

forbidden by the statute. Charter, 443 F.3d at 992-93. In so

doing, the court eschewed any analysis of the statutory text itself;

instead, it interpreted this Court’s prior cases to have given

Section 10(b) a narrow application only to defendants “who []

make or affirmatively cause to be made a fraudulent

misstatement or omission, or who [] directly engage in

manipulative securities trading practices.” Jd. at 992. Indeed,

in Credit Suisse, the Fifth Circuit elaborated on the Charter

court’s reasoning by arguing that the word “deceptive” was not

to be interpreted in accord with its dictionary definition, but in

accord with (what it perceived to be) this Court’s “limit” on the

“scope” of the term. 482 F.3d at 389. The Eighth and Fifth

Circuits’ interpretations of Central Bank and this Court’s other

cases are unduly constrained and ignore the plain statutory text.

B. The Eighth Circuit’s Overly Narrow Interpretation

of Section 10(b) Should be Rejected

The Eighth Circuit’s decision rested on three basic

propositions. First, as described above, it construed Section

10(b) to forbid only two forms of conduct: false statements (or

misleading omissions) and manipulative stock trades. Charter,

443 F.3d at 992. Second, the court determined that because the

vendor-defendants in this case had not directly made any false

Statements, and had not engaged in manipulative trading, they

could only be held liable for misleading omissions. /d. Third,

the court concluded that because the vendors had no fiduciary

relationship with Charter’s shareholders and had not personally

issued false statements, they were under no duty to disclose the

fraud. /d. Each of these conclusions was in error.

12

i. Section 10(b) Forbids All Forms of

Manipulative and Deceptive Conduct

This Court has interpreted the language of Section 10(b) to

prohibit “any course of conduct that has the effect of defrauding

investors,” Ernst & Ernst, 425 U.S. at 212, and has made clear

that a deceptive course of conduct, within the meaning of Section

10(b), includes participation in a “scheme” to defraud. In Ernst

& Ernst, for example, this Court defined “device” as

“an invention; project; scheme; often, a scheme to deceive.”

425 U.S. at 199 n.20. Similarly, in Superintendent of Insurance

v. Bankers Life & Casualty Co., 404 U.S. 6 (1971), this Court

approvingly quoted the Second Circuit that Ҥ 10(b) and Rule

10b-5 prohibit all fraudulent schemes in connection with the

purchase or sale of securities, whether the artifices employed

involve a garden type variety of fraud, or present a unique form

of deception. Novel or atypical methods should not provide

immunity from the securities laws.” /d. at 10 n.7 (quoting A. 7

Brod & Co. v. Perlow, 375 F.2d 393, 397 (2d Cir. 1967)).

Despite the statutory text and this Court’s clear admonition

that a// forms of manipulation and deception are forbidden by

the statute — including participation in “schemes” — the Eighth

Circuit nonetheless reached the conclusion that Section 10(b)

forbids only two things: false statements (and misleading

omissions), and “manipulative securities trading practices.”

443 F.3d at 992. Further, though the statute by its terms applies

to anyone who employs a manipulative or deceptive device

“directly or indirectly,” the Eighth Circuit eschewed this

language and instead held that only defendants who “make or

affirmatively cause to be made” false statements, or who

“directly engage” in manipulative trading, are covered by Section

10(b). Jd. Such narrow statutory construction is not only flatly

at odds with this Court’s prior holdings, but confuses the source

of the injury experienced by the plaintiffs with the conduct that

led to the injury.

13

The plaintiffs in this action claim that they were defrauded

by Charter’s false reports of revenues and cash flows. Complaint

412 (JA20a). Thus, the plaintiffs have alleged that they were

injured by a false statement, just as the Eighth Circuit required.

The only remaining question, then, is whether liability exists

for the deceptive conduct that underlies and causes the false

statement to issue. And by the plain terms of the statute, it does.

First, there can hardly be any dispute that plaintiffs have

alleged that the contracts, wash transactions, and the like were

“employed” by the vendors. The vendors are alleged to have

signed the contracts, accepted overpayments, and funneled

revenues back to Charter. Complaint $990-114 (JA52a-61a).

The vendors actively engaged in the transactions, and thus

“employed” them for statutory purposes. See Webster’s New

International Dictionary 839 (2d ed. 1934) (defining “employ”

as “to make use of, as an instrument, means, or material; to

apply; use;... .”).

Second, as the Ninth Circuit explained in Simpson, it is

difficult to imagine how participation in a transaction,

“the principal purpose and effect of which is to create the false

appearance of fact,” 452 F.3d at 1048, can be anything other

than “deceptive” under any understanding of that term. The

vendors here were alleged to have entered into sham contracts

and wash transactions, and they were alleged to have done so

for the purpose of having those transactions be communicated

to the public through Charter’s financial statements. This is the

very definition of deceptive. See, e.g., Webster’s New

International Dictionary 679 (2d ed. 1934) (“tending to deceive;

having power to mislead”).

The Eighth Circuit faltered at this point by limiting the

concept of a “deception” only to the issuance of a false statement

(or misleading omission), which, it concluded, the vendors had

14

not done. Charter, 443 F.3d at 992; see also Credit Suisse, 482

F.3d at 389 (conceding that the accounting structures at issue

qualified as “devices,” under this Court’s precedent, but

disputing that they were “deceptive”). But nothing in the statute

requires that a deceptive device be a false statement or omission.

Even if the Eighth Circuit is correct that ultimately the fraud

can only be consummated through a false statement or

misleading omission to the market, the statute forbids “devices”

and “contrivances,” not statements, and therefore must be taken

to forbid not only the statements themselves, but also those

devices and contrivances that cause false statements to issue.‘

This is why this Court has already explained that deceptive

“devices” include participation in a scheme. See Ernst & Ernst,

425 U.S. at 199 n.20. Such liability would be redundant if only

applied to those who had affirmatively made false statements;

rather, if the “devices” forbidden by the statute include

“schemes,” then they must necessarily include some forms of

conduct that, perhaps on their own are not direct false statements

to the market but, taken in conjunction with other actions,

+ Of course, had the truth behind Charter’s financial statements

been disclosed, there would have been no injury, but that fact alone

does not transform the case into one based on misleading omissions.

Because the securities laws are fundamentally directed at disclosure,

see, e.g., Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 8 (1985);

Santa Fe, 430 U.S. at 477 (“fundamental purpose of 1934 Act to

substitute a philosophy of full disclosure for the philosophy of caveat

emptor. . . .” (quotations omitted)), at bottom, every injury premised on

affirmative conduct can be reduced to a failure to disclose. See, e.g.,

United States v. O'Hagan, 521 U.S. 642, 655 (1997) (“if the fiduciary

discloses to the source that he plans to trade on the nonpublic

information, there is no ‘deceptive device’ and thus no

§ 10(b) violation.”); Zandford, 535 U.S. at 821 (unauthorized trading is

deceptive because it was undisclosed); Santa Fe, 430 U.S. at 477

(nondisclosure is “essential to the success” of a manipulative trading

scheme).

15

ultimately result in false communications. See, e.g., Webster’s

New International Dictionary 2234 (2d ed. 1934) (defining

scheme as a “plan or program of something to be done; an

enterprise; a project ... A crafty, unethical project”). And,

because this Court has already acknowledged that “[i]n any

complex securities fraud, [] there are likely to be multiple

violators,” Central Bank, 511 U.S. at 191, there is no reason

why the different parts that together constitute a “scheme” —

including a scheme to issue false financial statements — must

all be undertaken by a single actor.

To support its constricted reading of the statute, the Eighth

Circuit quoted Central Bank’s statement that “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.” Charter, 443 F.3d at 990 (quoting Central Bank, 511 U.S.

at 177). However, had the Eighth Circuit quoted the entire

passage, it would have been clear that the Central Bank Court

was concerned with deception, not particular forms of conduct:

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. See Santa Fe Industries [v. Green,] 430 U.S.

[462,] 473 [(1977)] (“language of § 10(b) gives no

indication that Congress meant to prohibit any

conduct not involving manipulation or deception”);

Ernst & Ernst, 425 U.S. at 214 (“When a statute

speaks so specifically in terms of manipulation and

deception . . . , we are quite unwilling to extend the

scope of the statute”). The proscription does not

16

include giving aid to a person who commits a

manipulative or deceptive act.

511 U.S. at 177. This paragraph is not an affirmative holding

that the only forms of conduct that violate §10(b) are

“statements” (and omissions), and “manipulations.” Read in

context, it is clear that the Court was addressing the broader

point whether liability would lie for any actions that were not,

in some sense, deceptive. This is why the Court cited Santa Fe

and Ernst & Ernst, both of which concerned only the question

whether unintentional or nondeceptive actions would violate

the statute, see Santa Fe, 430 U.S. at 473-74; Ernst & Ernst,

425 U.S. at 197-99, and why the Court, both in this paragraph

and elsewhere in its opinion, repeatedly referred less specifically

to deceptive “acts,” “conduct,” and “practices.”

Not surprisingly, then, in Credit Suisse, the Fifth Circuit

did not rely on this passage to support its conclusion that the

statute prohibits only statements, omissions, and manipulative

trading. Instead, the Fifth Circuit construed the Central Bank

decision as “informed by a series of decisions .. . narrowly

defining the scope of ‘fraud’ in the context of securities.” Credit

Suisse, 482 F.3d at 387. According to the Fifth Circuit, the

Central Bank Court, by relying on decisions such as Santa Fe

and Ernst & Ernst (which discussed the concept of

“manipulation”’), and Chiarella v. United States, 445 U.S. 222

(1980) (which noted that claims based on “omissions” must

include allegations of a “duty to speak”), had affirmatively

limited the scope of potential “manipulative” and “deceptive”

acts to the conduct specifically discussed in those opinions. See

Credit Suisse, 482 F.3d at 387-90. But a cursory glance at the

Central Bank decision shows that this is simply not so: Central

Bank relied on these cases not in the context of discussing the

types of acts that would violate the statute, but to make the

broader point that Section 10(b) liability turns on

17

misrepresentation, nondisclosure, or deception — which, the

Court believed, was not involved in aiding and abetting liability.

So, for example, the Court characterized the Ernst & Ernst

decision as turning on the need to “protect investors from false

and misleading practices,” 511 U.S. at 173-74, and described

Santa Fe as holding that Section 10(b) does not “reach[] breaches

of fiduciary duty ... without any charge of misrepresentation

or lack of disclosuze,” id. at 174. Nothing in Central Bank even

addresses whether conduct other than an affirmative statement,

Omission, Or manipulative trade might be considered

“deceptive,” and as explained above, the Central Bank Court

would have had no reason to decide the issue, because the

plaintiffs in that action “concede[d] that Central Bank did not

commit a manipulative or deceptive act.” /d. at 191.

The plaintiffs’ allegations here also satisfy the element of

reliance. As explained above, the plaintiffs’ injuries are

ultimately traceable to the false statements that Charter issued,

and in which the vendors participated. The only question is

whether the vendors’ deceptive conduct led to the issuance of

the false statements. See Credit Suisse, 482 F.3d at 397 (Dennis,

J., concurring). In this case, not only was the conduct essential

to the fraud, but it is also possible to identify exactly the false

information that the vendors injected into the market through

Charter, and its attendant effect on the value of Charter securities.

Therefore, the plaintiffs have properly alleged that they “relied”

on the false statements. See generally Basic Inc. v. Levinson,

485 U.S. 224 (1988) (element of reliance satisfied by a showing

that false information affected market price of the security).

Central Bank is not to the contrary. There, this Court

expressed concern that were the aiding and abetting action

proposed “in this case” to go forward, plaintiffs would be able

to proceed against the alleged aider and abettor, Central Bank,

18

without a showing of reliance. 511 U.S. at 180. But in that case,

Central Bank was alleged merely to have delayed an independent

assessment of property values underlying a bond issue, after

having already received an appraisal concluding the lands were

sufficient collateral. Jd. at 167-68. The court of appeals had

undertaken only a cursory analysis of the relationship of the

bank’s actions to the primary actor’s fraudulent bond issue, First

Interstate Bank, N.A. v. Pring, 969 F.2d 891, 904 (10th Cir.

1992), with no discussion of what an independent appraisal

might have yielded, when it would have been complete, or what

effect it might have had on the issue. In other words, in that

case, the relationship between Central Bank’s actions and the

ultimate injury was far more speculative than the relationship

alleged here. See Basic, 485 U.S. at 243 (explaining that the

element of reliance “provides the requisite causal connection

between a defendant’s misrepresentation and a plaintiff's

injury”).

Finally, holding outside entities liable under the facts of

this case does not threaten to revive aiding and abetting liability.

As explained above, the Central Bank Court rejected aiding

and abetting liability because it would have improperly extended

the proscription of §10(b) to those who merely aided persons

who committed manipulative or deceptive acts. The liability

proposed on the facts of this case would extend only to

defendants who engaged in transactions for the purpose of

creating a “false appearance of fact.” Simpson, 452 F.2d at 1048.

“The focus of the inquiry on the deceptive nature of the

defendant’s own conduct ensures that only primary violators

(that is, only defendants who use or employ a manipulative or

deceptive device) are held liable under the Act.” /d. at 1049.

19

ii. Participation in Fraudulent Conduct Triggers

a Duty to Disclose

The Eighth Circuit equally erred in concluding that those

who intentionally participate in sham transactions for the

purpose of enabling fraud have no duty to disclose that fact. To

the contrary, in the same way that a corporation, once it has

chosen to speak, must speak fully and truthfully, and correct

statements that were false when originally issued, see, e.g.,

Caiola v. Citibank, N.A., 295 F.3d 312, 331 (2d Cir. 2002);

Helwig v. Vencor, Inc., 251 F.3d 540, 561 (6th Cir. 2001) (en

banc); Overton v. Todman & Co., CPAs, P-C., 478 F.3d 479,

486 (2d Cir.-2007), Oran v. Stafford, 226 F.3d 275, 285-86 (3d

Cir. 2000); Backman v. Polaroid Corp., 910 F.2d 10, 17 (lst

Cir. 1990) (en banc), so too does intentional, active participation

in fraud give rise to a duty of disclosure.

In Chiarella, for example, this Court explained that a

“tippee” who wrongly receives confidential information from a

corporate fiduciary inherits the same fiduciary duties to disclose

the information or refrain from trading on it. See 445 U.S. at

230 n.12. As this Court explained, “the tippee’s obligation has

been viewed as arising from his role as a participant after the

fact in the insider’s breach of a fiduciary duty.” Jd.; see also

Dirks v. SEC, 463 U.S. 646, 659 (1983) (“[T]he tippee’s duty to

disclose or abstain is derivative from that of the insider’s duty.”).°

* In Dirks, a pre-Central Bank case, the tippee-defendant had been

charged by the SEC with aiding and abetting the original breach. This

Court did not discuss the nature of the SEC charge, but merely discussed

the source of a tippee’s own duty to the corporation’s shareholders.

Notably, in Chiarella, which involved primary liability, this Court also

discussed the tippee’s own duty to shareholders, approvingly citing

Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228

(2d Cir. 1974), in which tippees were charged with primary violations

(Cont'd)

20

The tippee’s status as a participant, moreover, turns on his

knowledge; though he assumes no fiduciary obligations if he is

unaware of the wrongfulness of the insider’s conduct, the tippee

“assumes a fiduciary duty to the shareholders of a corporation

[when] . . . the tippee knows or should know that there has been

a breach.” Dirks, 463 U.S. at 647.

The Chiarella and Dirks decisions are by no means unusual;

numerous courts both before and after Central Bank have

recognized that the existence of a duty of disclosure depends

on an examination of several factors, including the defendant’s

degree of participation in the fraud and its level of scienter. For

instance, in Rudolph v. Arthur Andersen, 800 F.2d 1040 (11th

Cir. 1986), the Eleventh Circuit explained that a court may

consider, among other things, “the extent of the defendant’s

knowledge and the significance of the misstatement .. . . The

extent of the defendant’s participation in the fraud might also

be important.” Jd. at 1043; see Ziemba v. Cascade Int'l, Inc.,

256 F.3d 1194, 1206 (1 1th Cir. 2001) (same). Similarly, the Ninth

Circuit has explained that a duty to disclose arises from the

“knowing assistance of or participation in a fraudulent scheme.”

Harmsen, 693 F.2d at 944 (quotation omitted).° Indeed, the

(Cont'd)

of Section 10(b). Today, the SEC regularly charges tippees with primary

violations of Section 10(b). See, e.g., SEC v. Warde, 151 F.3d 42, 47 (2d

Cir. 1998); SEC v. Franco, 253 F. Supp. 2d 720, 727 (S.D.N.Y. 2003).

6 Though the Ninth Circuit discussed this disclosure duty in the

context of aiding and abetting liability, as described above, that court

also defined such liability more strictly than did this Court in Central

Bank. See Harmsen, 693 F.2d at 943. Moreover, courts’ failure to

carefully distinguish aiding and abetting from primary liability prior to

Central Bank makes the labels unenlightening; though the Ninth Circuit

described this disclosure duty as “secondary,” the Eleventh Circuit relied

in part on Ninth Circuit precedent when it determined that violation of

a disclosure duty arising from participation in fraud constitutes primary

liability under Section 10(b). See Rudolph, 800 F.2d at 1043.

21

Restatement (Second) of Torts, relied upon in Chiarella, 445

U.S. at 228 n.9, emphasizes that there may be a duty to disclose

“facts basic to the transaction, if [the defendant] knows that the

other is about to enter into it under a mistake as to them, and

that the other, because of the relationship between them, the

customs of the trade or other objective circumstances, would

reasonably expect a disclosure of those facts.” Id. § 551(2)(a)

(emphasis added). The comments note that courts have required

disclosure in situations where “the advantage taken of the

plaintiff's ignorance is so shocking to the ethical sense of the

community, and is so extreme and unfair, as to amount to a

form of swindling,” id. cmt. k.

Under the standards elucidated above, the Eighth Circuit

was simply wrong to hold that third parties have no duties to

disclose frauds committed by the people with whom they do

business. When those third parties not only have actual

knowledge of fraud, but also intentionally participate in it —

through sham transactions, or artificial structures designed with

the purpose and effect of enabling improper accounting

treatment, or “any other cunning devices,” Ernst & Ernst, 425

U.S. at 202 — those third parties inherit the same duties of

disclosure as the original corporation, and may be liable for

breaching that duty by remaining silent. Certainly, a person

would “reasonably expect disclosure” if a third party, such as a

vendor or a lender, knew that its transactions were being falsely

described to the public. Cf Rudolph, 800 F.2d at 1044 (“Standing

idly by while knowing one’s good name is being used to

perpetrate a fraud is inherently misleading.”).

Nor would imposing a disclosure duty under circumstances

such as these revive the aiding and abetting standards rejected

in Central Bank. Central Bank concerned only “reckless,” not

“purposeful,” behavior. Central Bank, 511 U.S. at 190. This is

a relevant distinction, for it is the third party’s level of knowledge

22

about the wrongdoing of the original fiduciary that gives rise to

the reasonable expectation of disclosure and the derivative

fiduciary duties. See Dirks, 463 U.S. at 661 (“[Tippee]

responsibility must be related back to insider responsibility by

a necessary finding that the tippee knew the information was

given to him in breach of a duty .. .” (quotation omitted));

Rudolph, 800 F.2d at 1043 (“A defendant who intentionally did

not reveal what he knew to be fraud might more reasonably be

expected to speak out than a defendant who merely failed to

learn of a material but ambiguous omission.”). Moreover,

Central Bank did not examine the liability of one who furthers

the fraud by engaging in transactions intentionally structured

for the purpose of being falsely reported to the public — but this

is precisely the conduct that distinguishes one who gives

“a degree of aid” to persons engaging in fraudulent conduct,

511 U.S. at 176, from the type of active participation that triggers

the derivative fiduciary duty of disclosure.

iii. Section 10(b) Forbids Entities from Using

Others as Conduits to Distribute False

Information to the Public

Finally, the Eighth Circuit erred in concluding that the

vendors cannot be held responsible under Section 10(b) for

Charter’s false statements. To the contrary, when an entity

deliberately supplies false information to another party with the

purpose and intent that it be communicated to the public, that

entity has violeted Section 10(b). Because the vendors here are

alleged to have purposefully supplied Charter with false

information in the form of sham contracts and fictional rate

increases, they, too, are liable for false public communications

that incorporated such information.

It is widely agreed among the circuits that a person cannot

escape liability under Section 10(b) by using another person as

23

a “conduit” to communicate false information to the market.

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

corporation was accused of having provided false information

to analysts, who then used that information to issue unduly

positive recommendations to the public. See id. at 623-24.

Notwithstanding the fact that the false information had been

channeled to the market through third parties, the Ninth Circuit

explained that “corporate defendants may be directly liable under

10b-5 for providing false or misleading information to third-

party securities analysts.” /d. at 624. As that court explained, a

defendant “cannot escape liability simply because it carried out

its alleged fraud through the public statements of third parties.”

Id. (quoting Warshaw v. Xoma Corp., 74 F.3d 955, 959 (9th Cir.

1996)). Cooper’s holding that entities may not use other persons

as “conduits” to channel false information to the market has

won wide acceptance among the courts of appeals. See Rombach

v. Chang, 355 F.3d 164, 174 (2d Cir. 2004) (quoting Elkind v,

Liggett & Myers, Inc., 635 F.2d 156, 163-64 (2d Cir. 1980));

Southland Secs. Corp. v. INSpire Ins. Solutions, Inc. , 365 F.3d

353, 373 (Sth Cir. 2004); In re Navarre Corp. Secs. Litig., 299

F.3d 735, 743 (8th Cir. 2002). Indeed, even the Charter court

apparently recognized the validity of the theory, for it carefully

allowed that liability would attach if a defendant “affirmatively

cause[d] to be made a fraudulent misstatement or omission.”

Charter, 443 F.3d at 992.’

” The 1934 Congress was unquestionably aware of, and concerned

about, the use of ostensibly independent parties to funnel false

information to the market. As the Senate Committee report explained:

Other devices commonly resorted to in the past, and banned

by the bill are the dissemination of false information and

tipster sheets. The record shows that it was not uncommon

for market operators to employ a publicity agent to tout a

stock in which they were momentarily interested. In one

(Cont’d)

24

If there were any remaining doubt, it would be resolved by

looking to common law at the time of the Act’s passage.* At

that time, the Restatement (First) of Torts explained:

The maker of a fraudulent misrepresentation in a

business transaction is subject to liability to another

who acts in justifiable reliance upon it if the

misrepresentation, although not made directly to the

other, is made to a third person for the purpose of

having him repeat its terms or communicate its

substance to the other in order to influence his

conduct in a particular transaction or type of

transaction.

Restatement (First) of Torts § 533. For the purposes of this

(Cont'd)

instance a financial writer on a great New York newspaper

was discovered to have been a regular participant in the

profits of a free-lance trader, without obligation except to

publicize the stocks of the trader. Another witness admitted

that his business was ‘financial publicity’, and that his

articles were published for the purpose of interesting the

public in the stock in which he and those who employed

him were interested, theréby causing the market value of

the stock to increase; and for this work he was paid by

calls and options. Still other cases were observed where

persons were employed to broadcast over the radio,

ostensibly as economists tendering gratuitous advice, but

in reality as publicity agents of stock-exchange firms.

S. Rep. No. 792, 73d Cong., 2d Sess., at 8 (1934).

* The Exchange Act was passed in part to broaden the common

law protections against fraud, see Herman & MacLean v. Huddleston,

459 U.S. 375, 389 (1983); therefore, common law understandings of

fraud are helpful in understanding the type of conduct Congress sought

to prohibit.

25

principle, it is irrelevant that the vendors may not have had their

own independent pecuniary interest in defrauding Charter’s

shareholders. As the Restatement explained, “[t]he

misrepresentation must be made for the purpose of having it

repeated in terms or communicated in substance to the third

person. If it is made for such purpose, the rule is applicable

although the maker of the representation has no interest, either

direct or indirect, in the transaction in which its repetition

influences the third person.” /d. cmt. b.?

To be sure, the Second Circuit, relying on Central Bank,

held in Wright v. Ernst & Young LLP, 152 F.3d 169 (2d Cir.

1998), that to trigger Section 10(b) liability, false information

distributed through another entity must be publicly attributed

to its original source. See id. at 175. The circuit reasoned that

there can be no “reliance” if the public is unaware of the origin

of the statement. See id. But the Wright court — apparently

unwilling to overrule the conduit theory (which carries no such

caveat) — drew a distinction between “primary” actors who

channel false statements to the market through intermediaries,

and “secondary” actors who do the same thing, holding only

that “a secondary actor cannot incur primary liability under the

Act for a statement not attributed to that actor at the time of its

dissemination.” /d. at 175."°

* The Restatement (Second) of Torts espouses the same principle.

See Restatement (Second) § 533.

'° In Wright, the “secondary actor” was alleged to have done no

more than simply review and approve the false statements. Wright, 152

F.3d at 175. The Second Circuit observed that even if secondary actors

could be responsible for unattributed statements, the defendant’s

participation in that instance was likely too slight to incur liability. See

id. at 175-76. In this case, of course, the vendors are alleged to have

done far more than simply “review” Charter’s statements; they are

alleged to have contributed substantive, and false, content.

26

As should be immediately obvious, there is simply no basis

in the statute or even logic to draw such a distinction. If an

investor must know the identity of the original source of the

information in order to “rely” on it, there is no reason why that

rule should be any different when the anonymous participant is

a “secondary” rather than a “primary” actor. More importantly,

people rely on information, not speakers — and though the

perceived source of the information may contribute to its

materiality (a statement by a corporate issuer might carry more

weight than, say, a statement by a lone internet commenter) —

the relevant question is whether information supplied by the

(anonymous) actor was relied upon by the public. Indeed, this

Court itself has previously held that secondary actors can be

held liable under Section 10(b) when they assist in the

preparation of statements that are not attributed to them — it is,

in fact, the potential for such liability that distinguishes liability

under Section 10(b) from liability under Section 11 of the

Securities Act of 1933, and was one of the reasons that this

Court held that Section 11 was not the sole remedy for false

statements in registration statements:

[C]ertain individuals who play a part in preparing

the registration statement generally cannot be

reached by a Section 11 action. These include

corporate officers other than those specified in

15 U.S.C. § 77k(a), lawyers not acting as “experts,”

and accountants with respect to parts of a registration

statement which they are not named as having

prepared or certified. If, as Herman & MacLean

argues purchasers in registered offerings were

required to rely solely on Section 11, they would

have no recourse against such individuals even if

the excluded parties engaged in fraudulent conduct

while participating in the registration statement. The

27

exempted individuals would be immune from federal

liability for fraudulent conduct even though Section

10(b) extends to “any person” who engages in fraud

in connection with a purchase or sale of securities.

Herman & MacLean v. Huddleston, 459 U.S. 375, 386 n.22

(1983).

Therefore, it is hardly surprising that most courts have

not embraced Wright's “attribution” theory or its distinction

between “primary” and “secondary” actors — Wright is mainly

cited for a variety of other propositions. See, e.g., Weiss v. S.E.C.,

468 F.3d 849, 855 (D.C. Cir. 2006) (citing Wright for the

proposition that a defendant “could incur liability for his

misrepresentations even when he did not communicate them

directly to investors”); Fidel v. Farley, 392 F.3d 220, 235 (6th

Cir. 2004) (citing Wright to support its finding of no liability

where auditor-defendant “did not assist in the preparation or

presentation of this financial information, nor did it ever express

an opinion about it.”).

Here, it is alleged that the vendors intentionally provided

false information to Charter — through sham price increases,

sham advertising revenues, false contracts, and so forth — for

the express purpose of having Charter then communicate that

information to the public via its financial statements. Though

ordinarily entering into a business transaction might not be

considered to be a “statement” or the furnishment of information

in the ordinary sense, as alleged here, the transactions were not

designed for ordinary business purposes but instead existed to

be communicated publicly. In other words, the transactions in

question were “employed” by the vendors as a device to mislead

the market. Thus, the Eighth Circuit was simply incorrect to

conclude that “[nJone of the alleged financial misrepresentations

by Charter was made by or even with the approval of the

28

Vendors,” Charter, 443 F.3d at 992; to the contrary, the vendors

supplied false information, and most certainly approved of

Charter’s misrepresentations, by intentionally engaging in sham

business transactions for their informational value.

Nor is it relevant that, in this instance, Charter officers knew

that the information supplied by the vendors was false when

they incorporated it into Charter’s public statements. In Cooper,

many of the analyst-conduits were alleged to have known that

the corporation was feeding them false information, and yet the

corporation was still deemed liable for false information that

was channeled to the market. See Cooper, 137 F.3d at 625.

Moreover, joint participants in a fraud have long been treated

as equally liable, without any requirement that one be acting as

an innocent agent of another. See Dirks, 463 U.S. at 659 (the

transactions of those who knowingly participate with the

fiduciary in such a breach are “as forbidden” as transactions

“on behalf of the trustee himself” (quoting Mosser v. Darrow,

341 U.S. 267, 272 (1951)); Chiarella, 445 U.S. at 230 n.12

(“The tippee’s obligation has been viewed as arising from his

role as a participant after the fact in the insider’s breach of a

fiduciary duty.”); Huddleston, 459 U.S. at 659 n.22 (Section

10(b) liability will lie for all parties who “engaged in fraudulent

conduct while participating in the registration statement”);

Mertens v. Hewitt Associates, 508 U.S. 248, 254 (1993) (at

common law, knowing participants in a trustee’s breach of duty

were liable to the beneficiary).

Indeed, it seems that the only potential relevance of

Charter’s own belief, or not, in the false information supplied

by the vendors would be if Charter’s informed decision to

include the false information in its financial statements

constituted a supervening cause that broke the chain of causation

between the vendors’ conduct and the plaintiffs’ injuries.

However, it is by now well established that the intervening

29

conduct of another entity - even wrongful, or criminal conduct

— is not a supervening cause unless it is entirely unforeseeable

and unrelated to the original misconduct. See, e.g., Atchison,

Topeka & Santa Fe Ry. Co. v. Calhoun, 213 U.S. 1, 7 (1909);

Whitehead v. Food Max of Mississippi, Inc. , 163 F.3d 265, 271

(Sth Cir. 1998); Marshall v. Perez Arzuaga, 828 F.2d 845, 848

(ist Cir. 1987). Here, the vendors’ participation — far from being

divorced from plaintiffs’ injuries — was actually necessary to

Charter’s fraud; had they not agreed to engage in wash

transactions and other devices, Charter would not have been

able to falsify its financial statements in the manner alleged.

CONCLUSION

As succinctly stated by Circuit Judge Dennis concurring in

Credit Suisse, the interpretations of the Fifth and Eighth Circuits

“immunize[] a broad array of undeniably fraudulent conduct

from civil liability under Section 10(b), effectively giving

secondary actors license to scheme with impunity, as long as

they keep quiet.” 482 F.3d at 394 (Dennis, J., concurring). This

is not what the plain language of the statute requires, and cannot

be what was intended by the 1934 Congress. For that reason,

the Eighth Circuit’s decision should be reversed.

30

Respectfully submitted,

STANLEY D. BERNSTEIN

Counsel of Record

WILLIAM A.K. TITELMAN

CHRISTIAN P. SIEBOTT

ANN M. LIPTON

BERNSTEIN LIEBHARD & LirsHitz, LLP

10 East 40" Street

New York, New York 10016

(212) 779-1414

For Amici Curiae States of Arkansas,

New Jersey, and Rhode Island, and the

New York State Common Retirement Fund,

Pennsylvania Public School Employees’

Retirement System and Pennsylvania State

Employees’ Retirement System, and the

Municipal Employees’ Retirement System

of Michigan

Dustin McDANIeEL

Attorney General for the

State of Arkansas

Office of the Attorney General

323 Center Street, Suite 200

Little Rock, Arkansas 72201

(501) 682-2007

For the State of Arkansas

STUART RABNER

Attorney General for the

State of New Jersey

Office of the Attorney General

Richard J. Hughes Justice Complex

8" Floor, West Wing

25 Market Street

Trenton, New Jersey 08625-0080

(609) 292-4925

For the State of New Jersey

Patrick C, LYNCH

Attorney General for the

State of Rhode Island

150 South Main Street

Providence, Rhode Island 02903

(401) 274-4400

For the State of Rhode Island

LUKE BIERMAN

General Counsel to Thomas P. DiNapoli,

Comptroller of the State of New York

and, as such, Trustee of the New York

State Common Retirement Fund

110 State Street

Albany, New York 12236

(518) 474-3444

For the New York State

Common Retirement Fund

JEFFREY COOPER

Executive Deputy General Counsel

Commonwealth of Pennsylvania

333 Market Street

Harrisburg, Pennsylvania 17101

(717) 787-9352

GERALD GORNISH

Chief Counsel

Pennsylvania Public School

Employees’ Retirement System

5 North Fifth Street

Harrisburg, Pennsylvania 17101

(717) 720-4912

For the Pennsylvania Public

School Employees’ Retirement System

JEFFREY COOPER

Executive Deputy General Counsel

Commonwealth of Pennsylvania

333 Market Street

Harrisburg, Pennsylvania 17101

(717) 787-9352

MICHAEL A. Bupin

Chief Counsel

Pennsylvania State Employees’

Retirement System

30 North Third Street, Suite 150

Harrisburg, Pennsylvania 17101

For the Pennsylvania State

Employees’ Retirement System

MICHAEL J. Moquin

Chief General Counsel

1134 Municipal Way

Lansing, Michigan 48823

(517) 703-9030

For the Municipal Employees’

Retirement System of Michigan