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

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URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0280%3A30

## Record

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

## Text

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No. 06-43

IN THE

Supreme Court of the United States

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STONERIDGE INVESTMENT PARTNERS, LLC,

Petitioner,
v.
SCIENTIFIC-ATLANTA, INC., ET AL.,
Respondents.
On Writ Of Certiorari
To The United States Court Of Appeals
For The Eighth Circuit

BRIEF FOR FORMER SEC COMMISSIONERS AND
OFFICIALS AND LAW AND FINANCE PROFESSORS
AS AMICI CURIAE SUPPORTING RESPONDENTS

MARK A. PERRY

Counsel of Record
JONATHAN C. DICKEY AMANDA M. ROSE
GIBSON, DUNN & CRUTCHER LLP GIBSON, DUNN & CRUTCHER LLP
1881 Page Mill Road One Montgomery Street
Palo Alto, California 94304 San Francisco, California 90071
(650) 849-5300 (415) 393-8200

Counsel for Amici Curiae

TABLE OF CONTENTS

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INTRODUCTION AND SUMMARY OF

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I. The Text And Structure Of The Exchange
Act Preclude Imposition Of Scheme

Liability In Private Rule 10b-5 Actions...........

A. Scheme Liability Is Inconsistent With
Section 10(b), As Construed In Central

ROTATE MELT A, AY PO ENED

B. No Express Private Right Of Action

Recognizes Scheme Liability ...................

ll. The Policy Arguments Advanced By
Petitioner And Its Amici Do Not Justify
Deviation From The Text And Structure Of

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lll. Creating A Private Right Of Action Is A Job

For Congress, Not This Court........ .....:.::::006
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Page

wii 28

TABLE OF AUTHORITIES
Page(s)

Cases
Affiliated Ute Citizens v. United States,

Re Is csincectsintisisiessivusidiametateededinnnmeaiunineliia 10
Alexander v. Sandoval,

I inl alibiaieeialilae 24, 25
Anixter v. Home-Stake Prods. Co..,

igi & 5 3 REECE mnemonic 26
Basic Inc. v. Levinson,

ann SETI tc indintncianctennsiacinnincddeuninnaclinnentminddait 10
Blue Chip Stamps v. Manor Drug Stores,

ee ITI cxsducscnresctssedepunsuamnnipeciaceanniatnamecenieuslans 14
Central Bank of Denver, N.A. v. First Interstate

Bank of Denver, N.A.,

I EES ES ASAT RIN I passim
In re Charter Commce'ns, Inc. Sec. Litig.,

443 F368 DET (Bt Coe. 2ODG)....ncccccccscscesescsescoscsccseseses 4,27
Chiarelia v. United States, 445 U.S. 222, 233

TTS ee ire Mee enn MOE OOF TES 11
Credit Suisse Secs. (USA) LLC v. Billing,

og Bi. | DONE!

Dura Pharms.. Inc. v. Broudo,
I a 10, 13

ce

ill
In re Fannie Mae Sec. Litig.,
es ETT idl ccciscoricensitunpnsiantinsasbhaxenenbieabniaminieie 23
Fidel v. Farley,
| I 26

First Interstate Bank of Denver, N.A. v. Pring,
ee ne Oe EE le I icscsin tnasscecncsivescatonecsovveneseninl 9

In re Lernout & Hauspie Sec. Litig.,
236 F. Supp. 2d 161 (D. Mass. 2003)................:ccceceseees 21

Mahonia Ltd. v. JP Morgan Chase Bank,
2004 WL 1808816 (Q.B.D. (Comm. Ct.))
NS Sisal ceases dlchemiahcdecaitcineideinienitectinnii a 22

In re Parmalat Sec. Litig.,
376 F. Supp. 2d 472 (S.D.N.Y. 2005) ..0......cccccceceeseeeeees 21

Radzanower v. Touche Ross & Co.,
I 27

Regents of the Univ. of Cal. v. Credit Suisse
First Boston (USA), Inc.,
482 F.3d 372 (Sth Cir. 2007),
petition for cert. filed (Apr. 5, 2007) ........0:ccccccccccceeeseees 26

SEC v. J.P. Morgan Chase & Co.,
is UI I, so cs sisesinstitcinnesinsipsinninnd 21

Simpson v. AOL Time Warner, Inc.,
452 F.3d 1040 (9th Cir. 2006), petition for
es ts II sinedicsichs sceepiiinietpnmecittensciseceéncaeonenicen 21

Simpson v. AOL Time Warner, Inc.,
No. 04-55665 (9th Cir. Oct. 22, 2004)... 20

iV

Tellabs, Inc. v. Makor Issues & Rights, Ltd.,
No. 06-484, 551 U.S. (June 21, 2007)................. 25, 27

Transamerica Mortgage Advisors v. Lewis,
Ra I as sh cttaisshicabsicaipipicauenivimnunnenipennsaubidiiis 24

Wright v. Ernst & Young LLP,
a ee As BD ieicevcsceencncoseseunsesceswesneeneenesnt 26

Ziemba v. Cascade Int'l, Inc..,
256 F.3d 1194 (11th Cir. 2001)......................... se 26

Statutes, Regulations, and Legislative History

TN IEIEE INL I i iniek decsabsiscbeldsehininenichonianiobiinidiantipaignaboeccnaeldas 4
ett Peliosenbpesanicvencsenemnsesteinbsaninpseventniannnsnanonenalial 4,11, 12
oT te SEED Me saeor me ea em 19
I ac icadabeiaenmaaanerennaiaie 18
Ne Se aise cibslacisnridsicitiaaiiidiceiaanhatncennetionsndatitncannenmintintte 17
a eee IP iibitiieninsisusnsiecnepcscdincniessvinentnnruiinessubeneupheis 19
Fe ar NE vs ieriiecesviniisnenscisntetnieiinvesnamanenennemintel 4
BF i ee Ae SOs 6 HID vnccenesecessntinsacsenotesinesnesntenen 18
148 Cong. Rec. $6584 (daily ed. July 10, 2002)... 12
Re Ns PUR. SOU IID svntcnsiccssnesnerinnsncrncnniapennvsogoanses 12

Vv

Hearing: A Review of Investor Protection and
Market Oversight with the Five
Commissioners of the Securities and
Exchange Commission Before the House
Comm. on Financial Services, 110th Cong.,

Ist Session (June 26, 2007) ................cccesscsssccccccccessceecess 18
CU, UI TE CODD eisdciccesiccienssnessoiniuiensbiceceboaiibnds 12, 25
Other Authorities

Janet Cooper Alexander, Rethinking Damages in
Securities Class Actions, 48 STAN. L. REV.
TTT TaITTTIIE isin ssintiinciencsiiethdeeniataricdishiodiiadbiinceniiadannidieidiadie 16, 17

Vincent J. Badolato, SECURITIES LAW
TECHNIQUES (Matthew Bender 2006) ........00.000000.0000000. 19

Richard A. Booth, Who Should Recover What
For Securities Fraud?, University of
Maryland School of Law Legal Studies
Research Paper, No. 2005 (2005), available
at http://papers.ssrn.com/sol3/papers.cfm?-
I FIT Seitiebiinephinitensnitssiniiniimmpsinaiiiiesiiviaiaan 16

Stephen J. Choi & A.C. Pritchard, SECURITIES
REGULATION: CASES AND ANALYSIS (2005).....000.....00000 16

John C. Coffee, Reforming The Securities Class
Action: An Essay On Deterrence And Its
Implementation, 106 COLUM. L. REv. 1534
SEE cab cesvceinictonneiitaricnntionneaiainsaetebindiaamaiinetens 15, 16, 17

James D. Cox, Robert W. Hillman, & Donald C.
Langevoort, SECURITIES REGULATION:
CASES AND MATERIALS (5th ed. 2006)......0.....00.cccccceceee 16

vi

Frank H. Easterbrook & Daniel R. Fischel, THE
ECONOMIC STRUCTURE OF CORPORATE LAW

Daniel R. Fischel, Secondary Liability Under
Section 10(b) of the Securities Act of 1934,
Is I sd arssitc cmatmsndsconnedoosanetece 11

Joseph A. Grundfest, Scheme Liability: A
Question for Congress, Not for the Courts,
available at http://papers.ssrn.com/sol3/
papers.cfm?abstract 1d=1005524.............ccccee 22, 25, 27

Joseph A. Grundfest, Why Disimply?, 108
| cera ..20

INTERIM REPORT OF THE COMMITTEE ON
CAPITAL MARKETS REGULATION (2006)............ 15, 19, 20

Roberta S. Karmel, When Should Investor
Reliance Be Presumed In Securities Class
Actions?, Brooklyn Law School Legal
Studies Research Papers: Accepted Papers
Series, Research Paper No. 80 (forthcoming
in BUSINESS LAWYER 2007), available at
http://ssrn.com/abstract™ 1001743 ..........ccccccccceseseeeeeeees |

Donald C. Langevoort, Capping Damages For
Open- Market Securities Fraud, 38 ARIZ. L.
lad icine hanidncinsesedtieenecesscesoouns 15,17

2006 PERFORMANCE AND ACCOUNTABILITY
REPORT, U.S. Securities and Exchange
Commission, available at
http://www.sec.gov/about secpar/secpar2006

Vil

PRICEWATERHOUSECOOPERS LLP 2006
SECURITIES LITIGATION STUDY, available at
http://‘www.pwce.com/images/us/eng/about/s
ves/advisory/pi/SecLitStudy 2006 Final.pdf................ 18

A.C. Pritchard, Who Cares?, 80 WASH. U.L.Q.
TSE ASE RR Merete Rt ro hE Re oe RCN Oe oO 17

Larry E. Ribstein, Dabit, Preemption and
Choice of Law, 2006 CATO SUPREME COURT
IEE TET csindiictesdhntiinnbansiadilinnihintineindinneriectninncunceendene 16

David S. Ruder, Civil Liability Under Rule 10b-
5: Judicial Revision Of Legislative Intent?,
OF Pete Ss ins GEE IIE ccciictticecitencccntsenocccnesossestosees 14

SEC Release No. 19735, SEC v. Scientific-
Atlanta, Inc., Civ. Action No. 06 Civ. 4823
(PKC) (June 22, 2006), available at
http://www.sec.gov/litigation/litreleases/200

eI silncstidasiinsnsisiiciciteibnntnednimmanventractencesteneuens 18

Eric L. Talley, Cataclysmic Liability Risk
Among Big Four Auditors, 106 COLUM. L.
a iiss haa hiaicinbleentapnancbansiteinnibind 20

Anjan V. Thakor, The Economic Reality of
Securities Class Action Litigation (Navigant
Consulting 2005), available at
http://downloads.heartland.org/1833 | .pdf ..............0...... 16

INTEREST OF AMICI CURIAE*

Amici curiae include a bipartisan group of former
Chairmen, Commissioners and officials of the United States
Securities and Exchange Commission (SEC), as well as
prominent law and finance professors whose fields of aca-
demic inquiry include securities regulation, class-action prac-
tice, and law and economics. Amici have devoted substantial
parts of their professional careers to implementing, drafting,
and/or studying the federal securities laws, including how
those laws should be interpreted to ensure the protection of
investors and the promotion of efficiency, competition, and
capital formation.

This brief reflects the consensus view of the amici, all of
whom believe that the decision below should be affirmed.
Each individual amicus may not endorse every argument pre-
sented herein, however. The former Chairmen, Commission-
ers, officials, and professors joining this brief as amici, listed
alphabetically by category, are:

The Honorable Roderick M. Hills, who served as the
Chairman of the SEC from 1975 through 1977.

The Honorable Harvey L.. Pitt, who served as the Chair-
man of the SEC from 2001 through 2003, and who also
served as General Counsel of the SEC from 1975 through
1978.

The Honorable Harold M. Williams, who served as the
Chairman of the SEC from 1977 through 1981.

* This brief was not authored, in whole or in part, by coun-
sel for cither party, and no person or entity other than amici
and their counsel contributed monetarily to the preparation or
submission of this brief. See note |, infra. The parties have
consented to the filing of this brief and copies of their letters
of consent have been lodged with the Clerk of the Court.

2

The Honorable Charles C. Cox, who served as a Com-
missioner of the SEC from 1983 through 1989, and as Chief
Economist of the SEC from 1982 through 1983.

The Honorable Edward H. Fleischman, who served as a
Commissioner of the SEC from 1986 through 1992.

The Honorable Stephen J. Friedman, who served as a
Commissioner of the SEC from 1980 through 1981, and who
is the President of Pace University.

The Honorable Joseph A. Grundfest, who served as a
Commissioner of the SEC from 1985 through 1990, and who
is the William A. Franke Professor of Law and Business
and Co-Director of the Rock Center on Corporate Govern-
ance at Stanford Law School.!

The Honorable Isaac C. Hunt, Jr., who served as a
Commissioner of the SEC from 1996 through 2001.

The Honorable Roberta S. Karmel, who served as a
Commissioner of the SEC from 1977 through 1980, and who
is the Centennial Professor of Law at Brooklyn Law School.

The Honorable Philip R. Lochner, Jr., who served as a
Commissioner of the SEC from 1990 through 1991.

The Honorable Aulana L. Peters, who served as a Com-
missioner of the SEC from 1984 through 1988.

The Honorable Richard Y. Roberts, who served as a
Commissioner of the SEC from 1990 through 1995.

| Professor Grundfest has been retained by respondents to
provide counsel in this matter. In that capacity he submitted
a legal memorandum to the SEC that addressed some of the
subjects addressed in this brief. Professor Grundfest was not,
however, separately compensated in connection with the
preparation of this brief.

3

The Honorable Laura S. Unger, who served as a Com-
missioner of the SEC from 1997 through 2002, and as Acting
Chairman from February to August 2001.

The Honorable Steven Wallman, who served as a Com-
missioner of the SEC from 1994 through 1997.

James Doty, who served as General Counsel of the SEC
from 1990 through 1992.

Simon M. Lorne, who served as General Counsel of the
SEC from 1993 through 1996.

Professor Stephen M. Bainbridge, the William D. War-
ren Professor of Law at the University of California, Los An-
geles, Law School.

Professor Stephen J. Choi, the Murray and Kathleen
Bring Professor of Law, at New York University School of
Law.

Professor Robert C. Clark, the Harvard University Dis-
tinguished Service Professor, Austin Wakeman Scott Profes-
sor of Law, and Former Dean at Harvard Law School.

Professor John C. Coates, the John. F. Cogan, Jr.
Professor of Law and Economics at Harvard Law School.

Professor Richard A. Epstein, the James Parker Hall Dis-
tinguished Service Professor of Law and Director, the Law
and Economics Program, at the University of Chicago Law
School, and the Peter and Kirsten Bedford Senior Fellow at
the Hoover Institution.

Professor Allen Ferrell, the Greenfield Professor of
Securities Law at Harvard Law School.

Professor Larry E. Ribstein, the Mildred Van Voorhis
Jones Chair in Law at the University of Illinois College of
Law.

Professor Richard W. Roll, Ph.D, Japan Alumni Profes-
sor of International Finance, at the Anderson Graduate
Schuol of Management, University of California, Los Ange-
les.

a

4

Professor Roberta Romano, the Oscar M. Ruebhausen
Professor of Law and Director of the Center for the Study of
Corporate Law at Yale Law School.

Professor Kenneth E. Scott, the Ralph M. Parsons Pro-
fessor of Law and Business at Stanford Law School.

Professor Jeff Strnad, the Charles A. Beardsley Professor
of Law at Stanford Law School.

INTRODUCTION
AND
SUMMARY OF ARGUMENT

Petitioner, a professional money management firm, in-
vested in the common stock of Charter Communications, Inc.
On behalf of a shareholder class, petitioner sued Charter for,
inter alia, “entering into sham transactions with two equip-
ment vendors that improperly inflated Charter’s reported op-
erating revenues and cash flow.” Jn re Charter Commc'ns,
Inc. Sec. Litig., 443 F.3d 987, 989 (8th Cir. 2006). Petitioner
also sued the equipment vendors—respondents in this
Court—for taking part in this “scheme.” Petitioner alleged
that respondents “entered into these sham transactions know-
ing that Charter intended to account for them improperly and
that analysts would rely on the inflated revenues and operat-
ing cash flow in making stock recommendations.” /d. at 990.
Respondents, however, “did not issue any misstatement re-
lied on by the investing public, nor were they under any duty
to Charter investors and analysts to disclose information use-
ful in evaluating Charter’s true financial condition.” /d. at
992.

In Central Bank of Denver, N.A. v. First Interstate Bank
of Denver, N.A., 511 U.S. 164 (1994), this Court held that
there is no liability under Section 10(b) of the Securities Ex-
change Act of 1934, 15 U.S.C. § 78)(b), for “aiding and abet-
ting” a fraudulent act—i.e., only “primary” violators can be
sued under that statute and its implementing regulation, Rule
10b-5, 17 C.F.R. § 240.10b-5. Congress quickly amended
the Exchange Act to clarify that the SEC has enforcement
authority over aiders and abettors, whom it defined as those

5

who “knowingly provide[] substantial assistance to another
person in violation of [the Act],” 15 U.S.C. § 78t(e), but
withheld that authority from private class-action plaintiffs.
In this case, the lower courts correctly concluded that re-
spondents are secondary actors subject to the enforcement
authority of the SEC, but against whom there is no private
right of action under the rule of Central Bank. See 443 F.3d
at 992-93.

Petitioner’s core contention is that respondents should
have been categorized as primary violators under Section
10(b), and thus subject to liability in a private suit notwith-
standing Central Bank, because they allegedly participated in
a “scheme” to defraud Charter’s shareholders. Although pe-
titioner fails to articulate the contours of this theory of
scheme liability, it apparently would encompass at least those
entities that knowingly engage in “transactions with a public
corporation ... that enable[] the publication of artificially
inflated financial statements by the public corporation,” even
though the entities themselves did not trade in the public
company’s stock, owed no duty to investors, and “made no
public statements concerning those transactions.” Pet. Br. i.
Amici respectfully submit that knowingly “enabl[{ing]” a pub-
lic company’s commission of an alleged fraud in this manner
is a Classic description of secondary liability. Accordingly,
petitioner cannot maintain a class action against respondents
under Section 10(b) and Rule | 0b-S.

1. Both the text of Section 10(b) and the structure of the
Exchange Act preclude judicial implication of a private right
of action against a non-trading, non-speaking entity that
merely “enables” the commission of an alleged fraud by a
public company on its shareholders.

A. Petitioner’s “scheme liability” theory is simply a se-
mantic ploy designed to recast secondary conduct as a pri-
mary violation. The conduct at issue in Central Bank fits
squarely within petitioner's definition of “scheme liability.”
but this Court has already held such conduct to be secondary
to a primary violation and, thus, not actionable under Section
10(b). Mere knowing participation in another's alleged fraud

6

is not sufficient for liability to attach under that provision, as
Central Bank makes clear, and petitioner has not alleged that
respondents did anything more than that.

Following Central Bank, the SEC sought and received
congressional clarification that it may proceed against per-
sons, described as “aiders and abettors,” who knowingly pro-
vide substantial assistance to a person who commits a pri-
mary violation. Petitioner’s claim is that respondents know-
ingly provided substantial assistance to Charter, and thus re-
spondents would be subject to the SEC’s enforcement au-
thority. But Congress did not confer equivalent authority on
private plaintiffs; to the contrary, Congress has twice consid-
ered, but rejected, pleas to allow private claims against sec-
ondary actors. The Court should not do by fiat that which
Congress has expressly declined to do by legislation.

B. No express provision in any of the federal securities
laws allows investors to sue a non-speaking entity that did
not transact in the issuer’s securities and owed no duty to in-
vestors. Since Congress has never expressly authorized such
a private suit, there is no reason to assume that Congress im-
plicitly did so in Section 10(b). This Court has consistently
resisted expansive readings of the judicially implied private
right of action under Section 10(b). There is no warrant here
to recognize a liability theory that Congress has not previ-
ously made available to private plaintiffs under the securities
laws.

II. Policy considerations cannot override the text and
structure of the Exchange Act unless they show that adher-
ence to the statutory framework would lead to results so bi-
zarre that Congress could not have intended them. The pol-
icy arguments advanced by petitioner and its amici fall far
short of that standard.

A. Petitioner and its amici suggest that the private night
of action under Rule 10b-5 ought to be extended to cover
secondary actors to promote the policy goal of investor com-
pensation. But there is a broad consensus in the academic
community that the out-of-pocket measure of damages used

:

in Rule 10b-S class actions challenging aftermarket fraud is
economically irrational, because it bears little relation to the
actual net harm suffered by investors. The wisdom of ex-
tending the current Rule |0b-5 remedial scheme is therefore
far from obvious, particularly since the money paid to settle
Rule 10b-5 class actions is most often funded by other inno-
cent investors (and at considerable transaction costs). Fur-
thermore, the SEC can now itself provide investors with
meaningful compensation pursuant to its authority under the
“Fair Funds” provision in the Sarbanes-Oxley Act of 2002.

B. The deterrence justification for judicially implying a
private right of action premised on “scheme liability” is also
dubious, since substantial deterrents already exist. The SEC
and Department of Justice already can pursue claims against
aiders and abettors, and none of the briefs submitted by peti-
tioner and its amici demonstrates that additional deterrence is
necessary or appropriate at the margins. Moreover, private
“scheme liability” would give rise to substantial costs that
might exceed its questionable deterrent benefits. Because the
concept of “scheme liability” is not susceptible of precise
definition, defendants faced with scheme liability claims may
feel compelled to settle rather than risk expensive and pro-
tracted litigation. In addition, a defendant charged with
scheme liability often will face damages exposure greatly in
excess of the value of the transaction alleged to be part of the
scheme. The risk of such liability would factor into the price
of such transactions ex ante, raising the costs of doing busi-
ness for companies listed on the U.S. markets. It could also
stifle innovation in derivative transactions and other financial
products.

{Il. Whether to create a new private right of actlon—or
to extend an existing one—is a question appropriately di-
rected to Congress, not this Court. Congress thus far has
seen fit to give the SEC authority to pursue those who pro-
vide substantial assistance to primary violators of the securi-
ties laws, while withholding similar authority from private
plaintiffs. If Congress were to consider expanding the pri-
vate right, it would have to take into account a number of

8

competing policy considerations, including the impact of
such an expansion on efficiency, competition and capital
formation. It would also have to consider the proper parame-
ters of scheme liability, including whether to provide safe
harbors for derivative or other transactions. At the end of the
legislative process, Congress might decide—as it has twice
before—that the marginal costs of extending the private right
to cover secondary actors would exceed the marginal benefits
of such an extension, or it might decide that such an exten-
sion is warranted. But the very fact that a legislature could
reasonably reach either conclusion demonstrates that the de-
cision is not one for the Judiciary in the first instance.

ARGUMENT

Recognition of a private cause of action under Section
10(b) against non-trading, non-speaking entities that alleg-
edly do no more than knowingly “enable[]” fraud by a public
company (Pet. Br. i) is precluded by the text and structure of
the Exchange Act. The policy arguments advanced by peti-
tioner and its amici do not warrant deviation from that text
and structure; to the contrary, considerations of legal and
economic policy cast considerable doubt on the wisdom of
allowing private suits like petitioner's. Those doubts should
be resolved by Congress, not this Court.

I. The Text And Structure Of The Exchange Act
Preclude Imposition Of Scheme Liability In Private
Rule 10b-5 Actions

To determine whether a private plaintiff's claim may
proceed under Rule 10b-5, this Court has employed a two-
step statutory analysis. First, “the text of the statute con-
trols” with respect to the “conduct prohibited by § 10(b).”
Central Bank, 511 U.S. at 173. Second, “[w)hen the text of
§ 10(b) does not resolve a particular issue, [the Court] at-
tempt[s} to infer how the 1934 Congress would have ad-
dressed the issue.” /d. at 178 (internal quotation marks omit-
ted). Both steps of the statutory analysis compel affirmance
in this case.

9

A. Scheme Liability Is Inconsistent With Section
10(b), As Construed In Central Bank

Petitioner’s attempt to hold non-trading, non-speaking
entities such as respondents liable in an implied private ac-
tion under Section 10(b) founders on the language of the
Statute itself. The analysis in this regard can be boiled down
to two incontrovertible events: This Court’s decision in Cen-
tral Bank, and the congressional response to that decision.

1. Central Bank served as indenture trustee for bonds is-
sued subject to a covenant that they be secured by real estate
worth at least 160% of the bonds’ outstanding principal and
interest. Central Bank, 511 U.S. at 167. The bank was
“aware of concerns” regarding the value of the security, in
particular “the accuracy of the [pre-existing] appraisal.” /d.
at 168. A senior underwriter of the bond warned the bank
that the appraisal, which was then more than 16 months old,
“should be suspect and not relied on’” in light of declining
real-estate values. First Interstate Bank of Denver, N.A. v.
Pring, 969 F.2d 891, 894 n.5 (10th Cir. 1992). And the
bank’s own in-house appraiser expressed concern about the
values used in the appraisal. 511 U.S. at 167. Despite these
warnings, Central Bank acceded to the bond issuer’s request
to delay aun mdependent appraisal by six months, during
which time the issuer defaulted on a new issuance that, the
plaintiff alleged, would not have come to market absent Cen-
tral Bank’s agreement to defer the new appraisal. /d. at 167-
68.

This Court concluded that Central Bank’s conduct was
beyond the proscriptive reach of Section 10(b). Central
Bank, itself, “did not commit a manipulative or deceptive act
within the meaning of § 10(b),” as the plaintiffs there had to
concede. 511 U.S. at 191. Instead, Central Bank would have
had to be found “secondarily liable under § 10(b) for its
conduct in aiding and abetting the fraud’” committed by the
issuer. /bid. This Court concluded, however, that Section
10(b) reaches only primary violators. /bid. It therefore held
that the suit against Central Bank had properly been dis-
missed by the district court. /d. at 191-92.

10

As a comparison with the facts of Central Bank makes
clear, petitioner's “scheme liability” theory is simply a se-
mantic ploy designed to recast secondary conduct as a pri-
mary violation. The conduct at issue in Central Bank would
fit squarely within the definition of “scheme liability” that
petitioner proposes in this case (Pet. Br. i): Central Bank en-
gaged in a transaction with the issuer (i.e., an agreement to
defer the new appraisal) that “enabled” the issuer to publish
false statements (i.e., that the security covenant was satis-
tied), although the bank itself made no statement directly to
the bondholders. It follows a fortiori from Central Bank that
respondents here, who owed no duty to Charter’s sharehold-
ers and did net engage in any public misrepresentations (or
public deceptive acts), also did not engage in a primary viola-
tion (regardless of whether they “enable[d]” Charter’s alleg-
edly fraudulent scheme). See Chiarella v. United States, 445
U.S. 222, 233 (1980) (declining, in the absence of “explicit
evidence of congressional intent,” to “recogniz[e] a general
duty between all participants in the market” to refrain from
any act that may contribute to harm to other market partici-
pants).

Indeed, one of the central elements of the implied private
Rule 10b-5 action is the plaintiff's re/iance on the defen-
dant’s alleged wrongdoing. Dura Pharms., Inc. v. Broudo,
544 U.S. 336, 341 (2005). But petitioner, the plaintiff here,
cannot establish reliance on respondent:’ alleged wrongdo-
ing, either directly or by use of the fraud-on-the-market pre-
sumption: Again, respondents made no public misrepresen-
tations and engaged in no public deceptive acts (cf Basic Inc.
v. Levinson, 485 U.S. 224, 243 (1988)); moreover, given
their lack of duty, respondents cannot be charged with an ac-
tionable omission (cf. Affiliated Ute Citizens v. United States,
406 U.S. 128, 153 (1972)). Allowing a defendant to be held
“hable without any showing that the plaintiff relied upon [de-
fendant’s] statements or actions” would “circumvent the reli-
ance requirement [and] would disregard the careful limits on
10b-5 recovery mandated by . . . earlier cases.” Central
Bank, 511 U.S. at 180 (emphasis added); see also id. at 191
(describing a primarily liable party as one “who employs a

1]

manipulative device or makes a material misstatement (or
omission) on which a purchaser or seller of securities re-
lies”) (emphasis added); cf’ Roberta S. Karmel, When Should
Investor Reliance Be Presumed In Securities Class Actions?,
Brooklyn Law School Legal Studies Research Papers: Ac-
cepted Papers Series, Research Paper No. 80 at 39 (forthcom-
ing in BUSINESS LAWYER 2007), available at
http://ssrn.com/abstract=1001743 (observing that “extending
the fraud-on-the-market doctrine to statements by third par-
ties, who are not required to speak by SEC regulations, or do
not owe a duty to investors or shareholders” would be un-
wise, as it could “encourage too much questionable litiga-
tion’’).

As the Court put it in Central Bank, “(t]he proscription”
of Section 10(b) “does not include giving aid to a person who
commits a manipulative or deceptive act.” 511 U.S. at 177.
Central Bank itself recognized that knowing participation in
a “scheme” is simply another label for aiding and abetting
when it analogized an aiding-and-abetting claim under the
securities laws to a claim for “knowing participation in a
breach of fiduciary duty” under ERISA, and the Court re-
jected both under the text of the applicable statutes. /d. at
175, 176 (emphasis added); see also Daniel R. Fischel, Sec-
ondary Liability Under Section 10(b) of the Securities Act of
1934, 69 CAL. L. Rev. 80, 105-06 & n. 138 (1981) (arguing
that knowingly assisting another’s deceptive act does not vio-
late Section 10(b)). Petitioner has not alleged that respon-
dents did anything more than knowingly participate in Char-
ter's alleged fraud; this is a secondary violation in every
sense of the word.-

-

2 Contrary to the suggestion of petitioner's amici (Br. for
Charles W. Adams, et al. 3), interpreting the scope of Section
10(b) in accordance with its text would not allow the villain
Fagin, from Oliver Twist, to escape liability under the Ex-

[Footnote continued on next page]

12

2. In the wake of Central Bank, the SEC lobbied Con-
gress for clarification that it may pursue secondary actors.
Congress responded not by amending Section !0(b), but by
enacting a new Section 20(e), which provides:

Prosecutions of Persons Who Aid and Abet
Violations. For purposes of any action
brought by the Commission . . . , any person
that knowingly provides substantial assistance
to another person in violation of a provision of
this title, or of any rule or regulation issued
under this title, shall be deemed to be in viola-
tion of such provision to the same extent as
the person to whom such assistance is pro-
vided.

15 U.S.C. § 78t(e) (emphasis added).

Thus, if there were any question after Central Bank that
aiding and abetting liability includes “scheme liability,”
Congress laid it to rest by defining aiding and abetting liabil-
ity, for purposes of SEC enforcement actions, to include pre-
cisely that: Petitioner’s claim, at bottom, is that respondents
knowingly provided substantial assistance to Charter’s al-
leged fraud. But Congress consciously decided, both when it
enacted Section 20(e) in 1995 and again when it enacted Sar-
banes-Oxley in 2002—anot to extend the right to enforce this
liability to private plaintiffs. See S. Rep. No. 104-98, at 48
(1995) (“The Committee believes that amending the 1934
Act to provide explicitly for private aiding and abetting li-
ability actions under Section 10(b) would be contrary to S.
240’s goal of reducing meritless securities litigation”); H.R.
Rep. No. 107-414, at 54 (2002); 148 Cong. Rec. S6584 (daily
ed. July 10, 2002). This Court should not do, by fiat, that

[Footnote continued from previous page]

change Act. See 15 U.S.C. § 78t(a) (imposing control person
liability).

13

which the Congress has declined to do each time it has been
presented with the issue.

B. No Express Private Right Of Action
Recognizes Scheme Liability

Central Bank and the congressional reaction to that deci-
sion make clear enough that Section 10(b) does not encom-
pass scheme liability. The express private rights of action
that Congress chose to include in the Exchange Act only
serve to confirm that conclusion. No express provision in
any of the federal securities laws allows investors to sue a
non-speaking entity that did not transact in the issuer’s secu-
rities and owed no duty to investors. Since Congress has
never expressly endorsed petitioner’s theory of “scheme li-
ability,” it makes no sense to assume that Congress implicitly
did so for private Rule 10b-5 actions.?

The Court’s conclusion in Central Bank is equally appli-
cable here: “From the fact that Congress did not attach pri-
vate aiding and abetting liability to any of the express causes
of action in the securities Acts, we can infer that Congress
likely would not have attached aiding and abetting liability to
§ 10(b) had it provided a private § 10(b) cause of action.”
511 U.S. at 179. By parity of reasoning, the fact that Con-
gress has never seen fit to allow a private action premised on
“scheme liability” compels the inference that Congress
would not have authorized such liability in private Rule 10b-
5 actions. That inference is confirmed by the post-Central
Bank actions (and inactions) by Congress described in the
preceding section.

3 This is not to suggest that an entity that does speak,
breach a duty or transact in the issuer’s securities is necessar-
ily liable under Rule 10b-5. See Dura Pharms., Inc., 544
U.S. at 341 (listing the elements necessary to establish a pri-
vate Rule 10b-5 claim).

14

The implied right of action under Rule 10b-5 is of judi-
cial creation. This Court has repeatedly resisted expansive
readings of the implied right, recognizing that private securi-
ties litigation is susceptible to abuse. Blue Chip Stamps v.
Manor Drug Stores, 421 U.S. 723, 736 (1975) (“It would in-
deed be anomalous to impute to Congress an intention to ex-
pand the plaintiff class for a judicially implied cause of ac-
tion beyond the bounds it delineated for comparable express
causes of action”); Dura, 544 U.S. at 347 (rejecting plain-
tiffs’ claim that loss causation need not be alleged with speci-
ficity based on concerns about “abusive” practices”). There
is simply no warrant for the Court to adopt, or invent, a li-
ability theory that Congress has never expressly afforded to
private plaintiffs under the federal securities laws. Cf David
S. Ruder, Civil Liability Under Rule 10b-5: Judicial Revision
Of Legislative Intent?, 57 Nw. U. L. REV. 627, 660 (1962)
(because it is implied, the private right under Rule 10b-5
“should be interpreted with caution”).

il. The Policy Arguments Advanced By Petitioner
And Its Amici Do Not Justify Deviation From The
Text And Structure Of The Exchange Act

Petitioner and some of its amici suggest that private Rule
10b-5 liability ought to be extended to encompass “scheme
liability” in order to ensure investor compensation and ade-
quate deterrence. But such “[pjolicy considerations cannot
override [this Court’s] interpretation of the text and structure
of the Act, except to the extent that they may help to show
that adherence to the text and structure would lead to a result
‘so bizarre’ that Congress could not have intended it.” Cen-
tral Bank, 511 U.S. at 188. The arguments advanced by peti-
tioner and its amici fall far short of that standard.

A. Compensation

Petitioner and its amici urge this Court to characterize
those who merely “enable” another's fraud as primary viola-
tors in order to promote the goal of investor compensation.
But a broad consensus in the academic community recog-
nizes that the out-of-pocket measure of damages utilized in

15

Rule 10b-5 class actions challenging aftermarket fraud is
economically irrational. Innocent investors, rather than the
actual wrongdoers, most often fund the recovery in Rule 1 0b-
5 class actions. Given that diversified investors are unlikely,
over time, to suffer net harm from aftermarket securities
fraud, this very expensive system of investor self-insurance is
difficult to defend from a compensatory standpoint. The
wisdom of extending it to cover “scheme liability” claims is
therefore far from obvious.

1. Almost without exception, Rule 10b-5 class actions
that are not dismissed at the pleading stage result in settle-
ment, and the individual wrongdoers allegedly responsible
for the fraud rarely contribute. See John C. Coffee, Jr., Re-
forming The Securities Class Action: An Essay On Deter-
rence And Its Implementation, 106 COLUM. L. REv. 1534,
1550-51 (2006). Instead, the primary sources of settlement
payments are issuers, their insurers, and ancillary defendants.
See Janet Cooper Alexander, Rethinking Damages in Securi-
ties Class Actions, 48 STAN. L. REV. 1487, 1506 & n. 81
(1996). Each of these sources of funds may be traced back to
innocent investors: Payments by the issuer effect a direct
transfer of wealth from the issuer’s current shareholders to
the class members; payments by insurers are funded by pre-
miums paid by the insurer’s policyholders (issuers and, indi-
rectly, their innocent shareholders); and payments by ancil-
lary defendants, like accountants and investment banks, may
be charged back to issuers (and, indirectly, their innocent
shareholders) through increased fees due to litigation risk.
See Donald C. Langevoort, Capping Damages For Open-
Market Securities Fraud, 38 Ariz. L. REV. 639, 649 (1996).
Moreover, ancillary defendants may themselves be publicly-
owned companies, thus implicating yet another group of in-
nocent investors.

As a result, the amount that some investors gain from
private Rule 10b-5 class actions “will show up on the other
side of the capital marketplace ledger as roughly an equal
charge to other[]” innocent investors. Langevoort, 38 ARIz.
L. Rev. at 649. Rule 10b-5 class actions are therefore like a

16

very inefficient form of investor self-insurance—one that, as
explained below, diversified investors do not need. See IN-
TERIM REPORT OF THE COMMITTEE ON CAPITAL MARKETS
REGULATION at 79 (2006) (the transfer from diversified in-
vestors to other diversified investors “represents a pocket-
shifting wealth transfer that compensates no one in any
meaningful sense and that incurs substantial wasteful transac-
tion costs in the process”).

2. The loss suffered by an investor who purchased secu-
rities at an artificially inflated price is always matched with a
corresponding gain to the investor on the other side of the
transaction—thus, in a case of aftermarket fraud, innocent
investors earn a profit by selling their stock at a price inflated
by the fraud, and the law allows them to keep their profits.
Because it can be assumed that an innocent investor’s chance
of being on the losing or winning side of such a transaction is
random, a well-diversified investor’s gains and losses from
aftermarket securities fraud will tend to net out over time.4

4 See, e.g., Frank H. Easterbrook & Daniel R. Fischel, THE
ECONOMIC STRUCTURE OF CORPORATE LAW 339-341 (1991);
Richard A. Epstein, CASES AND MATERIALS ON TORTS, 8th
edition, 1124 n.4 (Aspen 2004); Stephen J. Choi & A.C.
Pritchard, SECURITIES REGULATION: CASES AND ANALYSIS at
348 (2005); James D. Cox, Robert W. Hillman, & Donald C.
Langevoort, SECURITIES REGULATION: CASES AND MATERI-
ALS 727-728 (Sth ed. 2006); Larry E. Ribstein, Dabit, Pre-
emption and Choice of Law, 2006 CATO SUPREME COURT
REVIEW 141, 147-152; Richard A. Booth, Who Should Re-
cover What For Securities Fraud?, University of Maryland
School of Law Legal Studies Research Paper, No. 2005-32
(2005) at 6, available at http://papers.ssmn.com/sol3/
papers.cfm?abstract_id=683197; Anjan V. Thakor, The Eco-
nomic Reality of Securities Class Action Litigation at |
(Navigant Consulting 2005), available at http://downloads.
heartland.org/18331.pdf: Janet Cooper Alexander, Rethinking

[Footnote continued on next page]

17

Such an investor would “perceive[] little good in a legal rule
that forces his winning self to compensate his losing self over
and over,” while paying substantial legal fees to boot.
Easterbrook & Fischel, THE ECONOMIC STRUCTURE OF CoR-
PORATE LAW 340; see also Coffee, 106 COLUM. L. REV. at
1537 (observing that “the burden of securities [litigation]
falls perversely on the victim,” which may explain “stock
price event studies that report that the subject company’s
stock price typically falls when a securities class action is
filed and that stock prices generally rise when legislation is
passed curtailing securities class actions”); Alexander, 48
STAN. L. REV. at 1502 (“the risk of litigation, unlike the risk
of securities fraud, cannot be diversified against because the
legal fees of both sides constitute a deadweight loss”).

This is not to say that aftermarket securities fraud causes
no harm to investors. But extending the remedy of out-of-
pocket compensatory damages to reach secondary violators
in aftermarket fraud cases, such as this one, is not the best
method for redressing that harm. Cf Langevoort, 38 Ariz. L.
REV. at 651 (the compensatory justification for private Rule
10b-5S actions “has relatively few informed, non self-serving
defenders”); Coffee, 106 CoLum. L. Rev. at 1545 (“From a
compensatory perspective, the conclusion seems inescapable
that the securities class action performs poorly”); A.C.
Pritchard, Who Cares?, 80 WASH. U. L.Q. 883, 884 (2002)
(“Securities class actions cannot be justified as providing
compensation”). This ts particularly true now that the SEC is
authorized to play an important role in providing compensa-
tion to investors through the “Fair Funds” provision in the
Sarbanes-Oxley Act of 2002. See infra at 18.

{Footnote continued from previous page]

Damages in Securities Class Actions, 48 STAN. L. REV. 1487,
1495-1496 (1996).

18

B. Deterrence

The deterrence-based policy arguments raised by peti-
tioner and its amici similarly fail to demonstrate that adher-
ing to the text and structure of the Exchange Act would lead
to a “*bizarre’” result. Central Bank, 511 U.S. at 188. Those
who assist another’s primary violation of Rule 10b-5 already
face significant sanctions at the hands of public enforcers; it
is therefore far from clear whether the additional marginal
deterrence that might result if private “scheme liability” were
recognized is even necessary. Nor is it clear whether the
benefits of this additional deterrence, if any, would exceed
the costs of expanding the scope of the implied right.

1. Those who aid and abet securities law violations face
considerable deterrents under the existing regime. The De-
partment of Justice, for example, can bring criminal charges
against those who aid and abet a securities law violation. See
18 U.S.C. § 2. As noted above, Congress has also conferred
authority on the SEC to pursue aiders and abettors, 15 U.S.C.
§ 78t(e)—authority the SEC has utilized to pursue allegations
identical to those in this case. See SEC Release No. 19735,
SEC v. Scientific-Atlanta, Inc., Civ. Action No. 06 Civ. 4823
(PKC) (June 22, 2006), available at http://www.sec.gov-
/litigation/litreleases/2006/Ir19735.htm; see also PRICEWA-
TERHOUSECOOPERS LLP 2006 SECURITIES LITIGATION STUDY
at 24-25, available at http://www.pwc.com/images/us/eng/
about/svcs/advisory/pi/SecLitStudy 2006 Final.pdf (detail-
ing public enforcement efforts in 2006).

The SEC has utilized its enforcement authority in recent
years to recover substantial penalties from securities law vio-
lators, money it has returned in large part to injured investors
pursuant to the Fair Funds provision in the Sarbanes-Oxley
Act of 2002. 15 U.S.C. § 7246: see also 17 C.F.R.
$§ 201.1100-201.1106. Indeed, the SEC has collected at
least $8 billion for distribution to harmed investors since
2002. See 2006 PERFORMANCE AND ACCOUNTABILITY RE-
PORT, U.S. Securities and Exchange Commission, available
at http://www.sec.gov/about/secpar/secpar2006.pdf. ‘It re-
cently reported that it has returned over $1 billion to inves-

19

tors since 2005. See Hearing: A Review of Investor Protec-
tion and Market Oversight with the Five Commissioners of
the Securities and Exchange Commission Before the House
Comm. on Financial Services, 110th Cong., Ist Session (June
26, 2007) (Statement of the Securities and Exchange Com-
mission) (noting that “[s]everal additional large disburse-
ments are pending and will be announced shortly”).

In addition to financial penalties, the SEC has available
to it a panoply of remedies that enable it to perform its deter-
rent function in a finely calibrated manner, depending on the
facts and circumstances of the particular case before it.
These remedies, the availability of which vary somewhat de-
pending on whether the Commission initiates an administra-
tive proceeding or files suit directly in federal court, today
include: officer and director bars; injunctive relief; cease and
desist orders; disgorgement of ill-gotten gains; and orders
requiring corrective disclosures and corporate governance
changes, among other things. See Vincent J. Badolato, SE-
CURITIES LAW TECHNIQUES §§ 87.06-87.07 (Matthew Bender
2006). Importantly, the SEC and DOJ can impose career-
and liberty-ending sanctions on individuals involved in
fraudulent activity. Public enforcement serves as a stronger
deterrent in this regard than private enforcement, as individu-
als are rarely made to contribute to the settlement of Rule
10b-5 class actions. See Coffee, 106 COLUM. L. REV. at
1550-51.5

In light of the amount of deterrence that already exists, it
is far from clear that the additional marginal deterrence that
might result from implying private “scheme liability” is even
necessary. See INTERIM REPORT OF THE COMMITTEE ON
CAPITAL MARKETS REGULATION at 78 (“the public value of

> The Sarbanes-Oxley Act of 2002 further protects against
fraud by, inter alia, imposing potential civil and criminal li-
ability for the false certification of the adequacy of internal
controls. See 15 U.S.C. § 7241; 18 U.S.C. § 1350.

20

the securities class action is questionable”). Nor, as dis-
cussed below, is it clearly desirable. Cf Eric L. Talley,
Cataclysmic Liability Risk Among Big Four Auditors, 106
CoLumM. L. REv. 1641, 1642 (2006) (“Auditors now face en-
hanced vulnerability to liability risks that—at least according
to some—threaten the very viability of the industry as we
know it”).

2. It is not clear that the potential marginal benefits of
Rule 10b-5 “scheme liability” class actions would exceed
their marginal costs, and petitioner and its amici have made
no such showing. More enforcement is not an unmitigated
good. To the contrary, “[i]f there is excessive securities liti-
gation, too many resources will be spent on litigation and on
litigation avoidance. The cost of capital will then increase
just as if a wasteful tax had been imposed on capital forma-
tion.” Joseph A. Grundfest, Why Disimply?, 108 HARV. L.
REV. 727, 732 (1995) (emphasis omitted). When liability
rules are unclear, the risk of overenforcement, and overdeter-
rence, is particularly acute. In recognition of this, the biparti-
san Committee on Capital Markets Regulation recently ad-
vised that “there needs to be greater clarity to private litiga-
tion under Rule 10b-5.” INTERIM REPORT OF THE COMMIT-
TEE ON CAPITAL MARKETS REGULATION at xu. It recom-
mended that the SEC provide more guidance on such things
as materiality, scienter, and reliance, to help ensure that the
U.S. capital markets stay competitive in the global economy.
Id. at 80-82.

Were this Court to recognize petitioner's theory of
“scheme liability,” it would inject confusion, not clarity, into
private litigation under Rule 10b-5. Not even proponents of
“scheme liability” can consistently define this amorphous
concept. Given this uncertainty. and the magnitude of the

6 Compare Br. of the SEC at 18, Simpson v. AOL Time
Warner, Inc., No. 04-55665 (9th Cir. Oct. 22, 2004) (defen-
dant must “engag[e] in a transaction whose principal purpose

{Footnote continued on next page]

21

potential damage awards, defendants in private Rule 10b-5
“scheme liability” cases might “find it prudent and necessary,
as a business judgment, to abandon substantial defenses and
to pay settlements in order to avoid the expense and risk of
going to trial.” Central Bank, 511 U.S. at 189.

Those involved in derivative securities transactions
might face a particularly strong pressure to settle, given that
such transactions commonly raise complex accounting, taxa-
tion, and reporting issues. In light of these complexities,
there exists a material probability that courts would allow
class action fraud claims predicated on derivative markets
transactions to move past the motion to dismiss stage, even
though the impropriety of the transaction may be subject to
considerable doubt—transactions that seem entirely legal to
one impartial fact-finder may seem problematic to another
fact-finder considering precisely the same facts. See gener-

[Footnote continued from previous page]

and effect is to create a false appearance of revenues”) with
Simpson v. AOL Time Warner, Inc., 452 F.3d 1040, 1048
(9th Cir. 2006), petition for cert. filed (Oct. 19, 2006) (No.
06-560) (“defendant must have engaged in conduct that had
the principal purpose and effect of creating a false appear-
ance of fact in furtherance of the scheme”; rejecting SEC's
suggestion that it is sufficient “that a transaction in which a
defendant was involved had a deceptive purpose and effect’)
(emphasis in original); /n re Parmalat Sec. Litig., 376 F.
Supp. 2d 472, 502-04 (S.D.N.Y. 2005) (defendant must have
“directly or indirectly used or employed any device or con-
trivance with the capacity or tendency to deceive”; rejecting
Lernout’s requirement of “substantial participation” as incon-
sistent with Section 10(b)’s text); and /n re Lernout & Haus-
pie Sec. Litig., 236 F. Supp. 2d 161, 173 (D. Mass. 2003)
(defendant must have “substantially participate{d] in a ma-
nipulative or deceptive scheme by directly or indirectly em-
ploying a manipulative or deceptive device . . . intended to
mislead investors”).

th
a

22

ally Joseph A. Grundfest, Scheme Liability: A Question for
Congress, Not for the Courts, http://papers.ssrn.com/sol3
/papers.cfm?abstract_id=1005524 at 14-15.

In this regard, it is illustrative to compare the British
High Court’s decision in Mahonia Limited v. JP Morgan
Chase Bank, West LB AG, 2004 WL 1808816 (Q.B.D.
(Comm. Ct.)) (Aug. 3, 2004), with the Commission’s en-
forcement action in SEC v. J.P. Morgan Chase & Co., No.
H-03-28-77 (S.D. Tex.). Both actions involved a series of
complex derivative transactions called “prepays.” The SEC
alleged that these transactions “had no business purpose aside
from masking the fact that, in substance, they were loans and
not swap contracts,” and should therefore have been ac-
counted for as loans. J.P. Morgan Compl. 41. The swap
counterparty (Chase) was alleged by the SEC to be liable as
an aider and abettor to securities fraud.’ In stark contrast, the
British High Court, having considered precisely the same
transactions, concluded (at *|236) that the “accounting for the
prepays was not in breach of US GAAP [and] that its ac-
counting for these transactions did noi constitute a breach of
US securities law.” The British High Court further con-
cluded that “[e]ven if there had been a breach of US GAAP,”
it “would not have found that there was any aiding and abet-
ting by Chase.” /d. 4240. Evidently, objective observers of
good faith can have differing views regarding the proper ac-
counting for a derivative markets transaction.

In addition to prompting defendants to settle defensible
cases and incentivizing plaintiffs to file questionable claims,
recognizing private “scheme liability” would give rise to
other costs. “Scheme liability” would expose those engaging
in commercial transactions with public companies to dispro-
portionate damages orders of magnitude greater than the size
of the transaction alleged to give rise to the liability, and for

? Chase settled the matter with the SEC. without admitting
or denying the allegations in the complaint.

23

misstatements or omissions that they, themselves, did not
make.’ This would encourage such parties to spend re-
sources monitoring the adequacy of their public counter-
party’s disclosures. These additional costs and the residual
risk of liability would likely be priced into those transactions
ex ante, burdening companies listed on the U.S. markets—
and, ultimately, their investors and customers.

Start-up and technology companies might feel the brunt
of these increased costs in their dealings with suppliers and
creditors, given that their volatile stock prices make them—
and those who deal with them—the most likely targets of se-
curities fraud class actions. Moreover, innovation in the fi-
nancial services area might be stifled for fear that new types
of transactions would be labeled as “deceptive,” and subject a
financial institution to huge liabilities. Indeed, if ‘scheme
liability” were recognized, particularly without transi :tional
safe harbor provisions of the sort that could be created only
by Congress, the implications for derivative trading, and its
continued presence in U.S. markets subject to U.S. prosecu-
tion, may be profound. It is not obvious that the additional
monitoring of public company disclosures that scheme liabil-
ity might prompt would create benefits in excess of these
costs.

8 In this case, for example, the total market capitalization
loss upon disclosure of a criminal investigation into Charter’s
practices was $7 billion. The amount of alleged inflation at-
tributable to respondents’ transactions with Charter, by con-
trast, was only $17 million. See also Second Am. Consol.
Class Action Compl. { 9, 25, /n re Fannie Mae Sec. Litig.,
MDL No. 1688 (D.D.C.) (alleging that Goldman Sachs vio-
lated Rule 1 0b-5(a) and (c) by “engineering” two transactions
that Fannie Mae purportedly accounted for erroneously, and
seeking to hold Goldman Sachs liable for Fannie Mae’s $12
billion loss of market capitalization even though its involve-
ment affected less than 1% of the alleged stock price infla-
tion).

24

This Court recognized the potential for these types of
“ripple effects” in Central Bank. 511 U.S. at 189. It ex-
plained that interpreting Section 10(b) to encompass aiding
and abetting liability would “exact[] costs that may disserve
the goals of fair dealing and efficiency in the securities mar-
kets.” /d. at 188. The Court declined to do so, based in part
on the fact that “the rules for determining aiding and abetting
liability are unclear, in ‘an area that demands certainty and
predictability.”” /bid. Uncertain risk of liability might cause
securities professionals to refuse to provide services to some
companies altogether, this Court explained, and might cause
them to increase the prices charged to others (prices “in turn
[paid] by the company’s investors, the intended beneficiaries
of the statute”). /d. at 189.

A similar sentiment influenced this Court’s recent deci-
sion in Credit Suisse Securities (USA) LLC v. Billing, 127 S.
Ct. 2383 (2007). The Court took as a given that the conduct
alleged in that case had been disapproved by the SEC, but
nonetheless observed that serious harm could come of sub-
jecting that conduct to private attack under the antitrust laws.
The Court exphained that “only a fine, complex, detailed line
separates activity” that the SEC permits and forbids, and that
“fijn light of the nuanced nature of the evidentiary evalua-
tions necessary to separate the permissible from the imper-
missible, it will prove difficult for... different courts to
reach consistent results.” /d. at 2394, 2395. Thus, allowing
private antitrust suits to proceed would likely “overly deter
syndicate practices important in the marketing of new is-
sues.” /d. at 2397. Decisions such as Central Bank and Bill-
ing confirm the wisdom of leaving the difficult policy ques-
tion whether to expand the private night of action under Rule
10b-5 to include “scheme liability” to Congress.

Ill. Creating A Private Right Of Action Is A Job For
Congress, Not This Court

The days of judicially-implied private rights of action
are long past. Alexander v. Sandoval, 532 U.S. 275, 287
(2001); Transamerica Mortgage Advisors, Inc. v. Lewis, 444
U.S. 11, 18-19 (1979). Under the modern regime, the deci-

oes

25

sion to create a new cause of action—or, equivalently, to ex-
tend an existing right of action—lies squarely with Congress,
not the courts. Sandoval, 532 U.S. at 288. This Court re-
cently reiterated as much in the context of the very statute at
issue in this case. Tellabs, Inc. v. Makor Issues & Rights,
Lid., No. 06-484, 551 U.S. __, slip op. at 15-16 (June 21,
2007) (“It is the federal lawmaker’s prerogative . . . to allow,
disallow, or shape the contours of—including the pleading
and proof requirements for—§ 10(b) private actions”). Con-
gress chose to leave it to the SEC alone to enforce scheme
liability. If petitioner and its amici believe that an expansion
of private securities litigation is advisable—in light of the
changes wrought by the PSLRA, or to better incentivize
gatekeepers to police for fraud, or for any of the other various
policy reasons set forth in the briefs in this case—they should
direct their proposals to Congress, not this Court.

In deciding whether to create a private right of action
premised on “scheme liability,” Congress would have to de-
termine whether the marginal benefits of doing so would ex-
ceed the marginal costs. As explained above, that would re-
quire the weighing of several difficult policy considerations.
To aid in that process, Congress could hear witnesses, re-
quest studies, and otherwise examine the empirical evidence
to predict the likely consequences of recognizing scheme li-
ability for capital formation, market efficiency, and consumer
welfare. If nothing else, the process would make a record
that would assist the Court in construing any resulting legis-
lation. Cf Tellabs, 551 U.S. _, slip op. at 10 (noting
PSLRA’s “twin goals: to curb frivolous, lawyer-driven liti-
gation, while preserving investors’ ability to recover on meri-
torious claims”).

Congress would also have to consider how “scheme li-
ability” should be defined, something neither the SEC (in its
enforcement capacity) nor the lower courts have been able to
agree on. See note 6, supra. It might also consider whether
to offer certain safe harbors to ensure that beneficial deriva-
tive transactions meant to hedge risks for investors are not
unnecessarily deterred. See generally Grundfest, Scheme Li-

26

ability: A Question for Congress, Not for the Courts, supra,
at 6-7. Or it might simply extend the Commission’s existing
power under Section 20(e) to private plaintiffs. Of course,
that Congress has thus far chosen nof to do so only reinforces
the wisdom of leaving this decision to Congress in the first
instance.

A responsible legislature would weigh these and similar
policy considerations before deciding to expand the private
right of action under Rule 10b-5 to encompass non-trading,
non-speaking entities such as respondents. See, e.g., S. Rep.
No. 104-98, at 48 (noting risks of meritless litigation raised
by private aiding-and-abetting liability). It could be that, at
the end of the legislative process, Congress would make the
political judgment that the benefits of a private “scheme li-
ability” regime would outweigh its costs. It could also be,
however, that Congress would determine that the marginal
benefits of recognizing private scheme liability, if any, are
far outweighed by the costs of such liability. The very fact
that the legislature could reasonably come out on either side
of this policy debate—a point that petitioner cannot dis-
pute—is sufficient to demonstrate that it is, at bottom, a leg-
islative decision, not a judicial one.

Most lower courts have properly recognized the limita-
tions on the Judiciary’s power to create or extend private
rights of action, and thus have refused to recognize “scheme
liability."? This majority view reflects a general consensus
among federal judges that, if scheme liability is to be recog-

9 Charter, 443 F.3d at 989; Regents of the Univ. of Cal. v.
Credit Suisse First Boston (USA), Inc., 482 F.3d 372 (Sth
Cir. 2007), petition for cert. filed (Apr. 5, 2007) (No. 06-
1341); Fidel v. Farley, 392 F.3d 220, 235 (6th Cir. 2004);
Ziemba v. Cascade Int'l, Inc., 256 F.3d 1194, 1213 (11th Cir.
2001); Wright v. Ernst & Young LLP, 152 F.3d 169, 175 (2d
Cir. 1998); Anixter v. Home-Stake Prods. Co., 77 F.3d 1215,
1226 (10th Cir. 1996).

27

nized at all, it should be done in the first instance by Con-
gress: Imposing liability for securities fraud based on trans-
actions “in goods or services other than securities . . . would
introduce potentially far-reaching duties and uncertainties for
those engaged in day-to-day business dealings. Decisions of
this magnitude should be made by Congress.” Charter, 443
F.3d at 992-93.

* * *

It has been observed that “[t]his is one of the most im-
portant securities cases to be heard by this Court in many
years.” Br. for William H. Donaldson, et al. 2. On this
point, amici joining this brief are in agreement. This is an
important case. It is important because it gives the Court the
opportunity to reconfirm that the securities laws mean what
they say, Te/labs, 551 U.S. __, slip op. at 12; that the securi-
ties laws should be construed to further market efficiency,
Billing, 127 S. Ct. at 2396; and that pure policy decisions are
for Congress in the first instance, Radzanower v. Touche
Ross & Co., 426 U.S. 148, 156 n.12 (1976). The Court's de-
cision in Central Bank reflects each of those principles. Ad-
herence to them requires affirmance of the judgment below.
Departure, by contrast, would “re-open a plethora of doc-
trinal issues regarding the interpretation of the federal securi-
ties laws that are today clearly resolved.” Grundfest, Scheme
Liability: A Question for Congress, Not for the Courts, su-
pra, at 3-4.

28

CONCLUSION . \

The judgment of the court of appeals should be affirmed.

Respectfully submitted.
MARK A. PERRY
Counsel of Record
JONATHAN C. DICKEY AMANDA M. ROSE
GIBSON, DUNN & CRUTCHER LLP GIBSON, DUNN & CRUTCHER LLP
1881 Page Mill Road One Montgomery Street
Palo Alto, California 94304 San Francisco, California 90071
(650) 849-5300 (415) 393-8200

Counsel for Amici Curiae

August 14, 2007

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0280%3A30. Public record. Not legal advice.