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

No. 06-43 ale

In The

Supreme Court of the Anited States

¢

STONERIDGE INVESTMENT PARTNERS, LLC,

Petitioner,

V.

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

Respondents.

+

On Writ Of Certiorari To The

United States Court Of Appeals

For The Eighth Circuit

¢

BRIEF OF THE NATIONAL ASSOCIATION ,

OF MANUFACTURERS AS AMICUS CURIAE

IN SUPPORT OF RESPONDENTS

¢

GEORGE M. NEWCOMDE

(Counsel of Record)

MICHAEL J. CHEPIGA

JAMES G. KREISSMAN

SIMONA G. STRAUSS

MICHAEL R. LIZANO

SIMPSON THACHER & BARTLETT LLP

2550 Hanover Street

Palo Alto, California 94304

(650) 251-5000

JAN S. AMUNDSON

Senior Vice President & General Counsel

QUENTIN RIEGEL

Vice President, Litigation & Deputy General Counsel

NATIONAL ASSOCIATION OF MANUFACTURERS

1331 Pennsylvania Avenue, NW

Washington, DC 20004-1790

(202) 637-3000

COCKLE LAW BRIEF PRINTING CO 800) 225-6964

OR CALL COLLECT | 402 5142-2831

TABLE OF CONTENTS

Page

ee IIE vintensercemnerennevnncmnmnecncaniontetecnmneien i

ee ee Caer I viciccocccecsepsesensencerencsnsveccvceses iii

INTEREST OF THE AMICUS CURIAE..............:00:0000 1

SUMMARY OF THE ARGUMENT ..............:csceseseeeseeees 2

EE nenteadctetentinsennriantinnnnnrsnpennenitaseanecninann: 5

I. PETITIONER’S PROPOSED “PURPOSE AND

EFFECT” STANDARD FOR IMPOSING

SCHEME LIABILITY IGNORES THE CLEAR

LANGUAGE OF SECTION 10(b) AND WOULD

CONSTITUTE A DRAMATIC DEPARTURE

FROM ESTABLISHED PRECEDENT .............. 5

A. Any Claim Asserted Under Section 10(b)

Or Rule 10b-5 Must Satisfy The “Use Or

Employ” And “In Connection With”

ID siciivinvsnisiscensiaiitiabiiiaiinniniens 5

B. The “In Connection With” Requirement Is

Satisfied Only If A Defendant’s Fraudulent.

‘Actions Necessarily Required Or Depended

Upon A Securities Transaction..................+. 6

C. A Defendant “Uses” Or “Employs” A

Deceptive Device Only If It Directs A

Specific And Affirmative Deceptive Act

I rceiccitcimienitimcnn 10

D. Petitioner Ignores Section 10(b)’s “Use

Or Employ” And “In Connection With”

Requirements, As Does Petitioner’s

Proposed “Purpose And Effect” Test............ 12

E. Section 10(b) Liability Requires A Breach

Of A Duty To Plaintiffs ..0..........ccceecseeeeeees 15

ii

TABLE OF CONTENTS - Continued

Page

II. PETITIONER’S PROPOSED “PURPOSE AND

EFFECT” TEST IS CONTRARY TO SOUND

FUSER PIRES scscnccnsscecmncnsenesesrepermanmnscserosseves 17

A. The Uncertainty Generated By Petitioner’s

“Purpose And Effect” Test Would Chill

Legitimate Commerce And Harm The

Economy As A Whole ...............:::sesscssseeseeeees 17

B. Petitioner's “Purpose And Effect” Test

Would Encourage Frivolous Claims,

Increase Defendants’ Cost Of Litigating

And Encourage Coercive Settlements.......... 22

C. Section 10(b) Jurisprudence Should Not

Be Premised Upon A Search For Deep

ill

TABLE OF AUTHORITIES

Page

CASES

Affiliated Ute Citizens of Utah v. United States, 406

ETRE TEESE IE AL AO OO OD 9,15

Bailey v. United States, 516 U.S. 137 (1995)................0000 11

Basic, Inc. v. Levinson, 485 U.S. 224 (1988).................008 16

Blue Chip Stamps v. Manor Drug Stores, 421 U.S.

SIP IIIIIUTI its buiicsiciihduetecinsibihimsanbdidlgncibeuinndestiite 17, 18, 24, 26

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

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

Chiarella v. United States, 445 U.S. 222 (1980)....13, 15, 16

Dirks v. S.E.C., 463 U.S. 646 (1983) ......... cee ce ceeeeeenenees 16

Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336

UNS is chisiciciiesesiciailhlphdiiitaed decid Gaal etainidiababeiteapibeiad 26, 28

Dutton v. D & K Healthcare Res., No.

4:04CV147SNL, 2006 WL 1778863 (E.D. Mo.

EES ie ee a 12,19

Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976).............. 5

Feldman v. Pioneer Petroleum, Inc., 813 F.2d 296

I a lle dstdinante 14

In re Charter Commce’ns, Inc. Sec. Litig., 443 F.3d

a ala aladdin 15, 29

In re Dynegy, Inc. Sec. Litig., 339 F. Supp. 2d 804

a I si ce ciniteeindinnteiaiipaioniasiidiie tS 19

In re Enron Corp., No. MDL-1446, Civ. Action No.

H-01-3624, 2006 WL 4381143 (S.D. Tex. June 5,

iv

TABLE OF AUTHORITIES - Continued

Page

In re Homestore.com, Inc. Sec. Litig., 252 F. Supp.

5 BE ak GA Ge ccctenscncintcinnensntisvinnitinntnaninentiit 19

In re Lernout & Hauspie Sec. Litig., 236 F. Supp. 2d

it 2 EU SESomerrarennn TE Ne Sn es, 19, 22

In re Parmalat Sec. Litig., 376 F.Supp. 2d 472

I Ts eee icicncincscceiisceiebesiinindibiniiatiited siti iat 19, 22

Jones v. United States, 529 U.S. 848 (2000)...........ccccccceees 11

Marine Bank v. Weaver, 455 U.S. 551 (1982)................... 14

McBoyle v. United States, 283 U.S. 25 (1931) ..............06. 17

McGann v. Ernst & Young, 102 F.3d 390 (9th Cir.

SIFU UD nc tcicuiscnpabicvipteindibcnstenideanamstebcamnanisupinapiditaieabinniesvniiinial 10

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

Dabit, 126 S. Ct. 1603 (2006).............c.ccccrsccecerorssees 17, 27

Pinter v. Dahl, 486 U.S. 622 (1988) ............cceeeeecceeeeeees 17,18

Piper v. Chris-Craft Industries, Inc., 430 U.S. 1

CIPO UP ctccnsacicnsnnssdescscosenssanetsatsanenteseaneiinanienentabideieninmeatal 7

Quaak v. Dexia, 357 F. Supp. 2d 330 (D. Mass.

TEIPUTEID wecnddsccsncsocnsntasentdeeriensniadeniasédemmmsncenimmiminiiadniaial 19, 23

Regents of the Univ. of Cal. v. Credit Suisse First

Boston (USA), Inc. , 482 F.3d 372 (5th Cir. 2007).......... 23

S.E.C. v. Zandford, 535 U.S. 813 (2002)................ 6, 7,9, 13

Santa Fe Indus. v. Green, 430 U.S. 462 (1977)...............6 15

Simpson v. AOL Time Warner Inc., 452 F.3d 1040

GE .cciiniiscsccsiscinisccnictetiimpiatnsduinmaslanditiiedainaensaisaice ieee 12

Superintendent of Ins. v. Bankers Life & Cas. Co.,

GG WE. GB CRG Ed ceccccececevccccsccccsssocsscccsnsnsinmicsneieniel 6, 7,8

TABLE OF AUTHORITIES -— Continued

Page

Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127

ia a talitemnme 24, 26

The Wharf (Holdings) Ltd. v. United Int’l Holdings,

CT 7,8

United States v. Cyprian, 197 F.3d 736 (5th Cir.

ene 11

United States v. O'Hagan, 521 U.S. 642 (1997).....5, 7, 9, 16

Wilson v. Garcia, 471 U.S. 261 (1985) ...............ccccceeeee eee ee 17

STATUTES

TT it tara an eremanetsinnenemeneunsnenenntiins passim

a anes es scp emrnneennensnnsioenanin 27

i is iaeinenecinsennennnncesensannenn 27

15 U.S.C. § 78u-4(f)( 2A) (2007)...........cceceecesseereeeseeeeeeeeeees 25

Private Securities Litigation Reform Act of 1995,

-- Pub. L. 104-69, 109 Stat. 737 (Dec. 22,°1995).......... ie

Securities Litigation Uniform Standards Act of

1998, Pub. L. 105-353, 112 Stat. 3227 (Nov. 3,

ae a 27

OTHER AUTHORITIES

Andrew S. Gold, Reassessing the Scope of Conduct

Prohibiued by Section 10(b) and the Elements of

Rule 10b-5: Reflections on Securities Fraud and

Secondary Actors, 53 Cath. U. L. Rev. 667

ec 11

H.R. Rep. No. 104-369 (1995) .....ceccccssesssssseessessvesseesseenveen 27

=

TABLE OF AUTHORITIES - Continued

Remarks of Sen. Sanford, 138 —_ Rec. $12605

CIES, TR, SD serctennmescenienntcenatirsnamsenniamatieesaninicnmene

Statement of J. Carter Beese, Jr., Chairman on

behalf of the Capital Markets Regulatory Reform

Project, Center for Strategic and International

Studies before the Subcommittee on Securities,

Committee on Banking, Housing and Urban

Affairs, 1995 WL 83860 (March 2, 1995)................0000

Testimony of Michael Morris, Vice President and

General Counsel of Sun Microsystems before the

Securities Subcommittee of the Senate

Committee on Banking, Housing and Urban

Affairs, 1998 WL 96483 (F.D.C.H.) (Feb. 23,

1

INTEREST OF THE AMICUS CURIAE'

The National Association of Manufacturers (the

“NAM”) is the nation’s largest industrial trade association,

representing small and large manufacturers in every

industrial sector and in all 50 states. The NAM’s mission

is to enhance the competitiveness of manufacturers by

shaping a legislative and regulatory environment

conducive to U.S. economic growth and to increase

understanding among policymakers, the media and the

general public about the vital role of manufacturing to

America’s economic future and living standards. In

support of this mission, the NAM regularly files briefs

amicus curiae in this Court and other courts.

The NAM does not condone securities law violations or

deceptive conduct in any form or for any purpose.

Nevertheless, the NAM opposes the position of Petitioner in

this case. The expansive and nebulous theory of scheme

liability advocated by Petitioner in this case lacks any basis

in the statutory text or the Court’s precedent and threatens

to ensnare law-abiding manufacturers in the costly web of

securities class action litigation based on -the..conduct of.

those with whom they do business. Were the Court to

adopt such a theory, American manufacturers would be

exposed to a greatly increased risk of frivolous securities

fraud litigation. Legitimate commerce would be chilled

both by the uncertainty inherent in Petitioner’s proposed

standard and by the heavy cost of defending against

frivolous securities litigation claims, undercutting

the competitiveness of the U.S. economy. America»

manufacturers can succeed only if the rules governing their

' This amicus brief is filed with all parties’ consent. No counsel for

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

entity other than amicus, its members and its counsel made a monetary

contribution to the preparation or submission of this brief.

2

potential liability are clear, as they have been under this

Court’s jurisprudence for the past several decades. The

NAM seeks to preserve this clarity for its members.

SUMMARY OF THE ARGUMENT

Petitioner urges this Court to dramatically expand the

private right of action under Section 10(b) of the Securities

Exchange Act of 1934 (the “Exchange Act”). Under

Petitioner’s proposed “purpose and effect” test, anyone

allegedly participating in a “scheme to defraud” investors

can be held liable under Section 10(b), regardless of

whether that actor had any contact with those investors or

owed them any duty. In arguing that the conduct of such

actors is encompassed by Section 10(b), Petitioner ignores

the language of the statute that explicitly limits its reach.

Petitioner also ignores this Court’s precedent, including

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

Denver, N.A., 511 U.S. 164 (1994), which prohibited private

rights of action against peripheral actors for the type of

aiding and abetting conduct that Petitioner now seeks to

capture under the rubric of “scheme liability.”

The broad expansion of actors subject to primary

liability under Section 10(b) that Petitioner seeks is

inconsistent with the statute’s requirement that liability

be based on the use or employment of a deceptive device

that occurs “in connection with the purchase or sale of any

security.” The “in connection with” requirement, as

repeatedly construed by this Court, limits the reach of

private civil actions under Section 10(b) to defendants

whose conduct necessarily requires or is dependent upon a

securities transaction. Thus, only those parties that make

a disclosure to investors, owe investors a specific fiduciary

duty or engage in insider trading can satisfy the “in

connection with” requirement. By contrast, those parties

3

who engage in commercial transactions with an issuer of

securities, such as the sale of goods and services, have not

acted in connection with a purchase or sale of securities.

They make no disclosures to their purchasers’

shareholders, owe them no fiduciary duty, and do not

engage in insider trading. Under these circumstances,

manufacturers should not be subject to liability under

Section 10(b). Nevertheless, Petitioner’s “purpose and

effect” test seeks to impose such liability on this broad

category of companies and individuals.

Petitioner’s “purpose and effect” test also ignores

Section 10(b)’s requirement that a defendant “use or

employ” a deceptive device in connection with a purchase

or sale of securities. This requirement limits Section 10(b)

liability to persons or entities who take an affirmative

action that deceives investors. In this case, and in

numerous other cases alleging “scheme liability,” the

vendor or purchaser of goods did not interact with the

issuer’s investors at all and, thus, did not “use or employ”

a deceptive device against them. Allegations that a third

party assisted a public company. that. .itself used- or

~ employed a deceptive device against its own shareholders

do not give rise to primary liability against the third party.

Instead, the third party may be held liable only for aiding

and abetting in a claim brought against it by the SEC.

Petitioner also ignores the well-established principle

that an actor cannot be liable for a Section 10(b) violation

unless it breaches a duty to investors. Such a duty can be

based on an existing fiduciary relationship between an actor

and investors or can arise by virtue of a statement that the

actor makes to investors. Here, as in many scheme liability

cases, Petitioner does not allege either that Respondents

made any misstatement to Charter’s shareholders or that

they owed them any other duty. Alleging that Respondents

4

acted as part of a “scheme” is insufficient to subject them

to Section 10(b) liability without the requisite duty.

Petitioner’s broad scheme liability theory is not only

contrary to precedent but it also is at odds with sound public

policy. The “purpose and effect” test proposed by Petitioner

would lead to great uncertainty among manufacturers and

others who do business with issuers of securities concerning

their potential securities fraud liability. This ambiguity in an

area of the law with enormous potential liability contravenes

the well-established goal of this Court to promote certainty

and predictability.

Moreover, were the Court to adopt the “purpose and

effect” test, plaintiffs would imvariably barrage

manufacturers and sellers of products with securities

fraud lawsuits every time they engaged in commerce with

a public company that improperly accounted for, or failed

to correctly describe, a transaction with them. The

vagueness inherent in the “purpose and effect” test would

make it difficult, if not impossible, for such third parties to

obtain dismissal of these claims under Rule 12(b)(6).

Therefore, third party manufacturers and sellers would be

forced to expend considerable sums defending themselves

in securities litigations where they neither made any

statements nor owed any duties to the investor class. The

heavy costs involved in defending these suits would allow

plaintiffs to coerce settlements. Additionally, the elevated

risk of incurring such costs and the potential imposition of

securities fraud liability would significantly increase the

costs of doing business for America’s manufacturers,

vendors and providers of goods and services. Such an

outcome would make American companies less

competitive, harm the domestic economy and discourage

foreign companies from doing business with domestic

companies, resulting in higher prices and fewer choices for

American consumers.

5

In sum, Petitioner’s scheme liability theory is contrary

to the language of Section 10(b), decades of precedent and

sound public policy. It is nothing but an attempt to revive

aiding and abetting liability under a different name. The

Court should affirm the decision of the Eighth Circuit and

reject Petitioner’s attempt to rewrite the securities laws.

ARGUMENT

I. PETITIONER’S PROPOSED “PURPOSE AND

EFFECT” STANDARD FOR IMPOSING SCHEME

LIABILITY IGNORES THE CLEAR LANGUAGE

OF SECTION 10(b) AND WOULD CONSTITUTE

A DRAMATIC DEPARTURE FROM ESTABLISHED

PRECEDENT

A. Any Claim Asserted Under Section 10(b) Or

Rule 10b-5 Must Satisfy The “Use Or Employ”

And “In Connection With” Requirements

Section 10(b) of the Exchange Act makes it “unlawful

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

means or instrumentality of interstate commerce or of the

mails, or of any facility of. any national securities exchange

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

sale uf any security, ... any manipulative or deceptive

device or contrivance....” 15 U.S.C. §78j (2007)

(emphasis added). These “use or employ” and “in

connection with” requirements apply to any Section 10(b)

claim, whether or not it alleges scheme liability under

Rule 10b-5(a) and (c).’

* See, e.g., Central Bank of Denver, N.A. v. First Interstate Bank of

Denver, N.A., 511 U.S. 164, 173 (1994) (“[A] private plaintiff may not

bring a [Rule] 10b-5 suit against a defendant for acts not prohibited by

the text of § 10(b).”); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 214

(1976) (same); United States v. O'Hagan, 521 U.S. 642, 651 (1997)

(“Liability under Rule 10b-5 ... does not extend beyond conduct

(Continued on following page)

6

Additionally, Central Bank makes clear that a

plaintiff can hold a defendant liable as a primary violator

only if the conduct of that defendant satisfies “all of the

requirements” of Section 10(b). 511 U.S. at 191. A plaintiff

cannot “borrow” an element of Section 10(b) liability from

one defendant and apply it to another defendant.

Accordingly, to maintain a claim against multiple

defendants, a plaintiff must show that each defendant

acted “in connection with the purchase or sale” of a

security and that each defendant “used or employed” a

deceptive device in so doing.

While Petitioner and its amici claim to base their

argument on the plain language of Section 10(b), they fail

to consider these important statutory elements. Instead,

they ask the Court to interpret the word “deceptive” in a

vacuum. Petitioner’s interpretation of “deceptive”

contradicts the clear statutory language of Section 10(b)

when the word is considered in context.

B. The “In Connection With” Requirement Is

Satisfied Only If A Defendant’s Fraudulent

Actions Necessarily Required Or Depended

Upon A Securities Transaction

To satisfy the “in connection with” requirement, a

defendant's conduct must “touch” upon or “coincide” with a

securities transaction. Superintendent of Ins. v. Bankers

Life & Cas. Co., 404 U.S. 6, 12-13 (1971) (“The crux of the

present case is that (plaintiff) suffered an injury as a

result of deceptive practices touching its sale of securities

as an investor.”); Zandford, 535 U.S. at 820 (“[Rlespondent’s

fraud coincided with the [securities] sales. . . .”).

encompassed by § 10(b)’s prohibition.”); S.E.C. v. Zandford, 535 U.S.

813, 816 n.1 (2002) (same).

7

This Court’s precedent demonstrates that the terms

“touch” and “coincide,” and the concept of dependence, are

not trivial or de minimis standards reaching any conduct

that happens to have some impact on the securities

markets. See Piper v. Chris-Craft Industries, Inc., 430 U.S.

1, 38 (1977) (phrase “in connection with the purchase or

sale of securities” is “limiting language”). To the contrary,

a defendant’s conduct “touches” or “coincides” with a

securities transaction only if completion of the defendant’s

alleged fraudulent act necessarily required or depended

upon a securities transaction. See, e.g., O'Hagan, 521 U.S.

at 656 (defendant’s fraud “consummated” by his securities

trades; fraud would not have existed without the improper

securities transactions — “in connection with” satisfied);

Zandford, 535 U.S. at 820-21 (emphasizing that securities

sales and defendant’s fraudulent acts “were not

independent events” because “each sale was made to

further [his] fraudulent scheme,” a scheme that “coincided

with” and “requirefd] the sale of securities” -— “in

connection with” satisfied) (emphasis added); id. at 820

(distinguishing hypothetical case where fraud would be

complete--either- before or after securities transaction

occurred -— “in connection with” not satisfied); Bankers

Life, 404 U.S. at 8 (fraudulent scheme to purchase

securities of corporation using that corporation’s own

assets depended upon sale of its securities — “in connection

with” satisfied); The Wharf (Holdings) Ltd. v. United Int'l

Holdings, Inc., 532 U.S. 588, 590-92 (2001) (plan not to

allow exercise of stock option sold to plaintiff necessarily

required sale of that option -— “in connection with”

satisfied).

An analysis of this Court’s decisions applying the “in

connection with” requirement shows that the requirement

is satisfied only when a defendant’s fraudulent activities

require or depend upon a securities transaction. In each

case, the “in connection with” requirement was satisfied

8

only if the defendant engaged in at least one of the

following acts: (i) making a misrepresentation or false

disclosure to investors; (ii) breaching a fiduciary duty owed

to plaintiffs; and/or (iii) engaging in insider trading.

Case Description | Misrepre-| Breach of Ler

to Duty

Investors?| Owed to

Plaintiffs?|

Superinten- v v

dent of Ins. v. |stoc

Banker Life {mis

Cas. Co.,

404 US. 6,

8 n.1 (1971)

The Wharf v

(Holdings)

Ltd. v. United

ntl

oldings,

ne., 532 US. . permit its

588, 596 exercise

2001) constituted

isrepresenta-

on to investor

Case Description | Misrepre-| Breach of| Insider |

tation | Fiduci -

Duty

7| Owed to

Plaintiffs?

S.E.C. v. Broker v

Zandford,

535 U.S. 813, [fiduciary duty

823 (2002) ed to his

ients

Affiliated Ute ket makers v

\Citizens of ached

Utah v. uciary duty

United States jowed to

406 U.S. 128, ities sellers

153 (1972)

United States (Defendant v

v. O'Hagan, Ibought call

21 U.S. 642, joptions based

7(1997) jon material,

mon-public

information

The-conduct alleged in each and every case in which this

Court has found the “in connection with” requirement to be

satisfied is conspicuously absent here. Petitioner here alleges

merely that Respondents agreed to sell set-top boxes to

Charter at inflated prices, to purchase advertising from

Charter using the money it received from the inflated prices

and to create new, backdated documents to reflect this

agreement. Completion of these transactions by Respondents

in no way required or depended upon any purchase or sale of

Charter securities. In addition, as Petitioner concedes,

Respondents made no misrepresentations to anyone, let

alone to Charter shareholders. Respondents owed no

fiduciary duty to Charter investors and did not trade in

Charter securities. Consequently, Petitioner’s allegations

about Respondents do not involve either the type of conduct

10

or the relationship to the securities markets necessary to

fulfill the “in connection with” requirement of Section 10(b).

Respondents therefore cannot be liable for a violation of Rule

10b-5.°

C. A Defendant “Uses” Or “Employs” A

Deceptive Device Only If It Directs A Specific

And Affirmative Deceptive Act Toward

Investors

This Court has not explicitly construed the terms

“use” or “employ” in the context of a Section 10(b) claim.

These words are straightforward and should be given their

plain meaning. Both “use” and “employ” are active verbs.

As such, they require some positive action. See McGann v.

Ernst & Young, 102 F.3d 390, 394 (9th Cir. 1996) (holding

that “the words ‘use’ and ‘employ’ require some positive

action”). Congress’ inclusion of this dynamic language

demonstrates that Section 10(b) requires a defendant to

engage in an affirmative act in order to be held liable.

Moreover, the full text of the statute demonstrates that not

any affirmative act will do. Instead, Section 10(b) requires a

defendant to “use” or “employ” a “deceptive device” “in

connection with the purchase or sale of securities.”

In order to use or employ a deceptive device within the

meaning of Section 10(b), a defendant must take an

* The NAM takes no position as to the propriety of Respondents’

conduct other than to state that the alleged conduct does not give rise

to a private claim for damages under Section 10(b).

* “Use” and “employ” had very similar and inter-referential dictionary

definitions when Section 10(b) was enacted. Webster’s New International

Dictionary (2d ed. 1934) defined “use” inter alia as “|t]o convert to one’s

service; to avail oneself of, to employ. ...” and “[t]o put into operation; to

cause to function. . . .” /d. at 2806. It defined “employ” inter alia as “to make

use of, as an instrument, means or material; to apply; use... .” Jd. at 839.

11

affirmative action and that action itself must deceive

someone. Merely participating in creating a deceptive

device does not satisfy the “use or employ” requirement.

That requirement is only satisfied by a party that uses or

employs the device to deceive investors. The act of creating

or facilitating a deceptive device constitutes, at most, aiding

and abetting another person’s primary Section 10(b)

violation. See Andrew S. Gold, Reassessing the Scope of

Conduct Prohibited by Section 10(b) and the Elements of

Rule 10b-5: Reflections on Securities Fraud and Secondary

Actors, 53 Cath. U. L. Rev. 667, 680-83 (Spring 2004)

(“Whatever degree of participation is demonstrated, if

someone else’s statements do the deceiving, the participant

still cannot be said to ‘use’ the device to deceive.”).”

Therefore, Charter’s alleged reporting of inflated

earnings to its investors based on its accounting for its

transactions with Respondents constitutes a primary

violation of Section 10(b). In order to deceive its investors,

Charter allegedly conspired with Respondents to create

inflated and backdated contracts. However, Respondents

themselves are not alleged to have used or employed these

* Holding that Section 10(b)’s utilization of the term “use or

employ” requires direct interaction with investors would be consistent

with the manner in which this Court has interpreted those terms in

construing other statutes. See, e.g., Bailey v. United States, 516 US.

137, 143 (1995) (federal statute imposing penalties for “use” of firearm

during or in relation to drug trafficking offense required “active

employment” of that firearm by defendant); United States v. Cyprian,

197 F.3d 736, 739 (5th Cir. 1999) (noting that various dictionary

definitions of “use” suggest “action and implementation”), Jones uv.

United States, 529 U.S. 848, 855 (2000) (federal statute prohibiting

destruction by fire or explosives of any building “used” in an activity

affecting interstate or foreign commerce required more than a mere

“passive, passing, or past connection to commerce”).

12

backdated contracts to deceive anyone.’ At most, Petitioner

alleges that Respondents facilitated the creation of a

deceptive device (i.e., the contracts) that Charter

thereafter used and employed to deceive investors.’ Such

conduct, if established, could amount to nothing more than

aiding and abetting Charter’s violation of Section 10(b),

and thus could not give rise to primary liability in a

private lawsuit brought under Section 10(b). Central

Bank, 511 U.S. at 191. This distinction between primary

and secondary violators is critical to manufacturers, who

have no contro] over their purchasers’ conduct, how their

purchasers will account for transactions, how they will use

documents associated with those transactions or whether

or how they will make disclosures to their shareholders

about any such transactions.

D. Petitioner Ignores Section 10(b)’s “Use Or

Employ” And “In Connection With”

Requirements, As Does _ Petitioner’s

Proposed “Purpose And Effect” Test

Petitioner pays scant attention to the “in connection

with” and “use or employ” requirements. In quoting the

statute, Petitioner conveniently omits any mention of the

* Respondents are not even alleged to have created the purported

scheme; Petitioner alleges that Charter devised the scheme and sought

participants in it. See Pet. Br. at 5-6.

” Petitioner does not suggest that Respondents misled Charter in

any way. This case is similar to most scheme liability cases, where

plaintiffs typically allege that the third party vendor conspired with the

issuer, rather than misleading it. See, eg., Simpson v. AOL Time

Warner Inc., 452 F.3d 1040 (2006); see also Dutton v. D & K Healthcare

Res., No. 4:04CV147SNL, 2006 WL 1778863 (E.D. Mo. June 23, 2006).

Moreover, as discussed above, even an allegation that Respondents

misled Charter would not be actionable under the securities laws

because it would fail to satisfy the “in connection with” requirement.

13

“use or employ” or “in connection with” language, stating

only that “Section 10(b) prohibits ‘any . . . deceptive device

or contrivance’ by ‘any person, directly or indirectly.’” Pet.

Br. at 18. Petitioner limits its discussion of the “use or

employ” requirement to one sentence in a footnote,

suggesting only that “employ” is a synonym for “use” and

that neither word requires any particular relationship

between the defendant and those injured by the conduct.

Id. at 20 n.6. Petitioner’s treatment of the “in connection

with” requirement is similarly negligible and conclusory.

Id. at 22 (asserting with little explanation that “[t)he ‘in

connection with’ language is more than satisfied here”).

Petitioner’s amici do not fare any better. With the

exception of quoting the text of Section 10(b), none of them

mention the “use or employ” or “in connection with”

requirements at all.

Instead, Petitioner urges the Court to adopt a test

that would hold third parties liable where “the purpose

and effect of [their] conduct [was] to create a false

appearance of material fact in furtherance of [a] scheme”

to defraud the issuer’s shareholders: -Pet.- Br. at 32.

Petitioner’s proposed test for scheme liability contradicts

the clear language of Section 10(b) and the prior holdings

of this Court.

First, the “purpose and effect” test ignores the “in

connection with” and “use or employ” requirements

entirely. Indeed, Petitioner’s test would be met any time a

common law fraud related in any way to securities.

This approach directly contradicts this Court’s warning

that “the statute must not be construed so broadly as to

convert every common-law fraud that happens to involve

securities into a violation of § 10(b)....” Zandford, 535

U.S. at 820; see also Chiarella v. United States, 445 U.S.

222, 232 (1980) (“[NJot every instance of financial

14

unfairness constitutes fraudulent activity under § 10(b).”).

Thus, Petitioner’s reading of the statute unduly expands

the scope of Section 10(b), despite the fact that “Congress,

in enacting the securities laws, did not intend to provide a

broad federal remedy for all fraud.” Marine Bank v.

Weaver, 455 U.S. 551, 556 (1982).

In addition, Petitioner's “purpose and effect” test

directly contradicts the Court’s holding in Central Bank.

Imposing liability on those whose conduct had “the

purpose and effect of ... creat[ing] a false appearance of

material fact in furtherance of [a] scheme” would allow

plaintiffs to evade Central Bank’s abolition of private

actions for aiding and abetting liability. Before Central

Bank, plaintiffs routinely labeled as “aiding and abetting”

the kind of conduct that Petitioner now claims satisfies its

“purpose and effect” test. See, e.g., Feldman v. Pioneer

Petroleum, Inc., 813 F.2d 296, 301 (10th Cir. 1987) (bank

“aided and abetted in a conspiracy to promote the scheme

by engaging in a fraudulent and deceptive transaction to

create the false appearance to prospective investors” that

a company would obtain loans from the bank).

Approval of Petitioner’s “purpose and effect” test

would revive aiding and abetting liability under a different

name. Over the past few decades, this Court and the

Congress have repeatedly attempted to curtail frivolous

securities fraud litigation. Creative plaintiffs have

attempted to circumvent these rulings, necessitating

repeated clarifications from this Court. Petitioner is

merely the latest in a long line of litigants that have

sought to find ways around this Court’s ruling in Central

Bank. The NAM respectfully suggests that this Court not

permit Petitioner to undermine the carefully developed

jurisprudence in this area.

15

E. Section 10(b) Liability Requires A Breach

Of A Duty To Plaintiffs

As the court below correctly stated, “[a)] device or

contrivance is not ‘deceptive,’ within the meaning of

§ 10(b), absent some misstatement or a failure to disclose

by one who has a duty to disclose.” In re Charter

Commce’ns, Inc. Sec. Litig., 443 F.3d 987, 992 (8th Cir.

2006) (citing Santa Fe Indus. v. Green, 430 U.S. 462, 474-

75 (1977)). The Eighth Circuit’s holding that duty (either

created by speaking to investors or as a result of a

fiduciary relationship) is a prerequisite to Section 10(b)

liability provides a bright line rule that is consistent with

this Court’s precedent.

In Affiliated Ute, the Court considered the failure of

market makers to disclose material information with

respect to certain stock sales. The Court paid particular

attention to the duty that the market makers owed the

plaintiff under Rule 10b-5. Had the defendants acted

merely as transfer agents, the Court explained, there

would have been no duty to disclose. Instead, the

defendants actively encouraged a market for the

securities; and thérefore were liable under Section 10(b)

because of their “affirmative duty” to disclose information

to investors. Affiliated Ute, 406 U.S. at 152.

The Court reaffirmed the importance of duty in

Chiarella, where it held that an employee of a financial

printer who bought stock after discovering the identity of

the target in a corporate takeover bid could not be liable

under Rule 10b-5(a) and (c) because he owed no disclosure

duty to the shareholders of that target corporation.

Chiarella, 445 U.S. at 228. As the Court held, omissions

are actionable only where there is a duty to disclose based

on a specific relationship between two parties. “The

element required to make silence fraudulent - a duty to

disclose — is absent in this case. No duty could arise from

16

petitioner’s relationship with the sellers of the target

company’s securities, for petitioner had no prior dealings

with them.” Jd. at 232.

The Court continued to emphasize duty in subsequent

Section 10(b) cases. See, e.g., Dirks v. S.E.C., 463 U.S. 646,

666-67 (1983) (holding that, in absence of a breach of a

fiduciary duty to shareholders by insiders who provided

defendant with inside information, there was no derivative

breach by the defendant and thus no liability); Basic, Inc.

v. Levinson, 485 U.S. 224, 239 n.17 (1988) (“Silence, absent

a duty to disclose, is not misleading under Rule 10b-5.”);

O’Hagan, 521 U.S. at 662 (reiterating that Section 10(b)

liability “is premised upon a duty to disclose arising from a

relationship of trust and confidence between parties to a

transaction”) (quoting Chiarella, 445 U.S. at 230).

In sum, this Court has employed the bright line “duty”

standard for Section 10(b) liability for the past several

decades. This standard has provided manufacturers and

vendors of products who engage in commercial transactions

with public companies with a clear standard on which they

could rely in shaping their conduct. Manufacturers and

vendors understand that under existing precedent, because

they owe no duty to the shareholders of those companies

with which they do business, they have no obligation to

make any disclosures to those shareholders. In the absence

of any material statements made by a manufacturer to its

purchasers’ shareholders, a manufacturer has no possible

civil liability under the securities laws to those

shareholders. The “purpose and effect” test advocated by

Petitioner diverges dramatically from these clear legal

principles. The NAM respectfully suggests that the Court

should reject this standard because it deviates from the

statutory language and ignores decades of precedent.

17

II. PETITIONER’S PROPOSED “PURPOSE AND

EFFECT” TEST IS CONTRARY TO SOUND

PUBLIC POLICY

A. The Uncertainty Generated By Petitioner’s

“Purpose And Effect” Test Would Chill

Legitimate Commerce And Harm The

Economy As A Whole

As it has in the past, this Court should consider the

policy implications of changing the scope of private civil

liability under Section 10(b) and Rule 10b-5. See, e.g., Blue

Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 739

(1975) (explicitly basing decision to limit standing under

Section 10(b) and Rule 10b-5 to purchasers and sellers

partly on policy considerations); Merrill Lynch, Pierce,

Fenner & Smith, Inc. v. Dabit, 126 S. Ct. 1503, 1510-11

(2006).

Such policy considerations include certainty and

predictability, oft-recognized and laudable goals of

statutory interpretation. See, eg., McBoyle v. United

States, 283 U.S. 25, 27 (1931) (“[Flair warning should be

given to the world in language that the common world-will

‘“Ginderstand, of what the law intends to do if a certain line

is passed. To make the warning fair, so far as possible the

line should be clear.”); Wilson v. Garcia, 471 U.S. 261, 275

(1985) (stating that the Court’s interpretation of a statute

was supported by federal interests in uniformity, certainty

and the minimization of unnecessary litigation).

Indeed, this Court relied on exactly such policy

considerations in eliminating the private right of action for

aiding and abetting liability. In Central Bank, this Court

noted that “(t]he rules for obtaining aiding and abetting

liability [were] unclear, in [securities litigation,] ‘an area

that demands certainty and predictability.” Central Bank,

511 U.S. at 188 (quoting Pinter v. Dahl, 486 U.S. 622, 652

(1988)). Lack of clarity “leads to the undesirable result of

18

decisions ‘made on an ad hoc basis, offering little

predictive value’ to those who provide services to

participants in the securities business.” Jd. The Court

concluded: “‘[S)uch a shifting and highly fact oriented

disposition of the issue of who may [be liable for] a

damages claim for violation of Rule 10b-5’ is not a

‘satisfactory basis for a rule of liability imposed on the

conduct of business transactions.’” Jd. (quoting Blue Chip

Stamps, 421 U.S. at 755) (emphasis added).

The Eighth Circuit’s test, supra at 15, promotes

certainty and predictability by informing companies that

they can be held liable as primary Section 10(b) violators

to the shareholders of another company only if they make

a disclosure to those shareholders or otherwise owe them a

duty. In contrast, under Petitioner’s test, a company doing

business with an issuer would be liable if the “purpose and

effect” of the conduct at issue was found to create a false

appearance of material fact in furtherance of a scheme to

defraud the issuer’s shareholders. That test provides

neither certainty nor predictability. Were the Court to

abandon decades of precedent and adopt Petitioner’s

proposed standard, a manufacturer would not know when

an issuer’s shareholder might allege that the issuer

misrepresented details about a transaction with the

manufacturer. Such a standard would offer manufacturers

virtually no guidance, let alone certainty, regarding their

potential liability.

Moreover, adoption of Petitioner’s proposed standard

would lead to an explosion of new scheme liability cases

against manufacturers and other third parties. Despite

the fact that this Court has never given any credence to

Petitioner’s scheme liability theory, there has been a

recent proliferation of scheme liability cases, as creative

plaintiffs have attempted to circumvent this Court’s

holding in Central Bank. The facts that plaintiffs consider

19

sufficient to give rise to securities fraud liability in these

cases demonstrate the risks inherent in throwing open the

floodgates of scheme liability by adopting Petitioner’s

proposed standard.

For example, vendors of goods and services have been

sued under Rule 10b-5 “scheme” liability for (i) providing

rebates on volume purchases of products because the

purchaser allegedly failed adequately to describe the

rebate program and its potential effect on the purchaser’s

business, Amalgamated Bank v. Dell, Inc., Civ. Action No.

1:07-CA-00077-LY (W.D. Tex. Jan. 31, 2007); (ii) providing

goods or services to a purchaser because the purchaser

allegedly misrepresented the transaction and inflated its

assets, Dutton, 2006 WL 1778863; and (iii) entering into

commercial transactions because the other party allegedly

recognized revenue improperly in connection with those

transactions, Jn re Homestore.com, Inc. Sec. Litig., 252

F. Supp. 2d 1018 (C.D. Cal. 2003).° If this Court were to

adopt Petitioner’s amorphous “purpose and effect” test, the

type of commercial entities that would be ensnared into

the “scheme” web would be limited only by plaintiffs’

counsel’s imagination.”

* Financial services firms also have faced scheme liability suits for

setting up and/or financing transactions that an issuer allegedly

misrepresented in its financial statements. See, e.g., 1n re Enron Corp.,

No. MDL-1446, Civ. Action No. H-01-3624, 2006 WL 4381143 (S.D. Tex.

June 5, 2006); Jn re Parmalat Sec. Litig., 376 F. Supp. 2d 472 (S.D.N_-Y.

2005); Quaak v. Dexia, 357 F. Supp. 2d 330 (D. Mass. 2005); In re

Dynegy, Inc. Sec. Litig., 339 F. Supp. 2d 804 (S.D. Tex. 2004); In re

Lernout & Hauspie Sec. Litig., 236 F. Supp. 2d 161 (D. Mass. 2003).

* Petitioner suggests that its proposed test will not create

unfairness or uncertainty because companies either are “good” (and

therefore not at risk of liability) or “bad” (and therefore not worthy of

protection). See Pet. Br. at 32-34. The idea that “good” companies have

nothing to worry about ignores practical reality. There is no reason to

believe a plaintiff will know (or act upon) the “truth” about a defendant

(Continued on following page)

20

Although the alleged facts of these recent scheme

cases vary slightly, they all have one thing in common. In

each, the third party had no contact with the issuer’s

shareholders, and it was the issuer that made an alleged

misrepresentation to its shareholders. As importantly, the

third party lacked any control over how the issuer

reported its dealings with the third party to its

shareholders. By linking a third party’s liability to the

issuer’s actions, Petitioner’s test requires the third party

to assume the risk that the primary violator will do

something inappropriate over which the third party has no

control.

The lack of certainty and predictability generated by

the “purpose and effect” test would have a chilling effect

on legitimate commerce and a negative effect on the

economy as a whole. It would ask manufacturers to

assume the costly and impossible role of watchdog over the

conduct of their customers to ensure that they properly

account for and disclose any transactions with that

manufacturer. For example, in order to limit their Section

10(b) liability:

¢ Manufacturers would be forced to analyze their

public customers’ disclosures and financial

statements to determine whether those

customers correctly reported and accounted for

transactions with the manufacturer;

¢ Manufacturers would be incentivized to do

business with foreign or private companies

rather than public U.S. companies to avoid

risking securities fraud liability;

ex ante and will only allege securities fraud against “bad” companies.

Plaintiffs and their counsel are not triers of fact and cannot be counted

on to serve a gatekeeper function.

21

¢ Manufacturers would hesitate to modify existing

contracts at their customers’ request for fear that

the modifications, if undisclosed to their

customers’ auditors, would allow manipulation of

their customers’ financial results;

¢ Manufacturers would balk at including legitimate

and competitively reasonable confidentiality

provisions in their agreements, fearing plaintiffs

would later claim those provisions reflect a

scheme to conceal material information from the

customers’ investors;

¢ Manufacturers would think twice before

advancing funds (e.g., seller financing) or offering

discounts to their customers out of concern that

the customers would improperly account for the

cash they received; and

¢ Manufacturers would be wary of doing business

with public companies with high stock price

volatility (e.g., technology companies) because

such companies could face greater potential

securities fraud liability.

business deals not only on their commercial merits but

also on their potential for crushing securities fraud

liability based on the conduct of a counterparty. That

analysis would have to be done for each of the millions of

sale transactions that take place annually. Adopting such

a legal standard would harm manufacturers, their

customers, the American consumer, and the U.S. economy

as a whole.

Additionally, the significant litigation costs and

possible broad liability imposed by the “purpose and effect”

test would increase manufacturers’ cost of production,

causing them to pass these costs on to their customers.

These price increases would undermine manufacturers’

22

competitiveness vis-d-vis foreign companies that do not

face such costs or the risk of such massive liability. See,

e.g., Statement of J. Carter Beese, Jr., Chairman on behalf

of the Capital Markets Regulatory Reform Project, Center

for Strategic and International Studies before the

Subcommittee on Securities, Committee on Banking,

Housing and Urban Affairs, 1995 WL 83860 (March 2,

1995) (“[F]Jrom my vantage point on the [Securities

Exchange] Commission, I became concerned that the costs

of regulation, and the costs of litigation, were placing an

unnecessary drag on the competitiveness of U.S.

companies and U.S. capital markets, and imposing

needless costs on consumers.”). By imposing this burden

on manufacturers, scheme theories such as the “purpose

and effect” test ignore the practical realities of conducting

business. Changing the scope of Section 10(b) in such a

drastic manner is the sole province of Congress, not the

courts.

B. Petitioner’s “Purpose And Effect” Test

Would Encourage “Frivolous Claims,

Increase Defendants’ Cost Of Litigating

And Encourage Coercive Settlements

If Petitioner’s “purpose and effect” test were adopted,

plaintiffs would be able to allege scheme liability - and

survive Section 12(b)(6) motions to dismiss — with relative

ease. The lower courts that have permitted scheme

liability formulations similar to Petitioner’s proposed

standard have done just that, permitting claims against

parties that did not speak to investors and owed them no

duty. See, e.g., In re Lernout & Hauspie, 236 F. Supp. 2d at

177 (defendants, including investment fund and insurance

company, owing no duty to issuer’s shareholders, allegedly

set up and funded outside sham entities that did business

with issuer — motions to dismiss denied); Jn re Parmalat,

23

376 F. Supp. 2d at 517 (defendant bank, owing no duty to

issuer’s shareholders, allegedly structured loans to issuer

and established invoice securitization program — motion to

dismiss denied in part); Quaak, 357 F. Supp. 2d at 342

(defendant bank, owing no duty to issuer’s shareholders,

allegedly structured loans to issuer ~ motion to dismiss

denied); Regents of the Univ. of Cal. v. Credit Suisse First

Boston (USA), Inc., 482 F.3d 372, 378 (5th Cir. 2007)

(“Enron”) (investment banks, owing no duty to issuer’s

shareholders, allegedly structured transactions with

issuer — motions to dismiss denied).

Adopting Petitioner’s standard would make it difficult

for manufacturers, vendors and service providers who

made no misrepresentations to plaintiffs, and who had no

duty to them, to extricate themselves from frivolous

lawsuits at an early stage.” Indeed, Petitioner’s vague test

would allow a plaintiff to survive a motion to dismiss just

by uttering the talismanic phrases, “scheme to defraud”

and “purpose and effect.”

Petitioner’s test is easy to allege and hard to refute on

a motion to dismiss. Consider, as a hypothetical, .that

Supplier: sells component parts for a finished product to

Manufacturer (a public company) with the understanding

that the parts can be returned by Manufacturer for any

reason within 60 days. Supplier includes the right of

return provision in a separate letter agreement, rather

than the purchase order. Manufacturer records the

purchase correctly in its financial statements. Supplier,

however, incorrectly records excess revenue from the sale

by claiming it is non-contingent and final and showing the

In addition, more manufacturers will be sued if plaintiffs can

ignore the limits of Section 10(b) (eg., the “in connection with”

requirement) by alleging scheme liability.

24

purchase agreement, but not the side letter agreement, to

its auditors. When the true nature of the transaction

comes to light, Supplier’s stock price falls and it files

for bankruptcy. Supplier’s shareholders then sue

Manufacturer for securities fraud, alleging that Supplier

and Manufacturer conspired to defraud them and that the

“purpose and effect” of the separate side letter was to

create a false appearance of material fact in order to

further the scheme. In this example, Petitioner’s “purpose

and effect” test would sweep a third party actor into costly

litigation merely because it engaged in a legitimate

transaction with an issuer that may not have disclosed the

transactions appropriately.

Additionally, the heavy cost of being mired in

meritless, intractable litigation would encourage non-

issuer defendants to enter into coercive settlements. Sce,

e.g., Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct.

2499, 2504 (2007) (“Private securities fraud acticns ..., if

not adequately contained, can be employed abusively to

impose substantial costs om companies and individuals

whose conduct conforms to the law.”); Blue Chip Stamps,

421 U.S. at 740 (“[E]ven a complaint which by objective

standards may have very little chance of success at trial

has a settlement value to the plaintiff out of any

proportion to its prospect of success at trial so long as he

may prevent the suit from being resolved against him by

dismissal or summary judgment.”).

Moreover, secondary actors often must expend large

amounts of money, even on pretrial matters. See 138 Cong.

Rec. S$12605 (Aug. 12, 1992) (remarks of Sen. Sanford)

(asserting that in many securities fraud cases, major

accounting firms pay eight dollars in legal fees for every

one dollar paid in claims). The General Counsel of Sun

Microsystems, for instance, testified before Congress as to

25

the effects of two frivolous securities fraud lawsuits that

had been filed against Sun:

[We] litigated these two matters vigorously,

spending over $2.5 million on attorney fees and

expenses in the period from June 1989 through

January 1993; our directors and officers liability

carrier spent approximately $2 million more. These

figures do not include the public relations costs,

many hours of senior management time diverted to

the litigation, and the uncertainty generated by the

situation. ... [Ojur Board regarded it as a matter

of fiduciary duty to explore settlement seriously,

even though the idea of settling was deeply

offensive to us. But the grim prospect of a jury

trial, with all of its inherent unpredictability, forced

us to consider any kind of “reasonable” settlement

that might be achieved. Accordingly, [we] agreed to

settle the first matter for $25 million, half of which

was paid by the insurance carrier; and the second

matter for $5 million, half of waich also was

paid by insurance. Of course, one-third of these

settlements went to plaintiffs’ counsel, not to any

shareholder.

Testimony of Michael Morris, Vice President and General

Counsel of Sun Microsystems before the Securities

Subcommittee of the Senate Committee on Banking,

Housing and Urban Affairs, 1998 WL 96483 (F.D.C.H.) (Feb.

23, 1998). Scheme liability cases would serve to increase

those litigation costs, and coerced settlements, unnecessarily.

The risk of coercive settlements is heightened for a

third party that may have had limited involvement with

an issuer but who potentially faces joint and several

liability for all of the issuer’s acts — acts over which it had

no control. See 15 U.S.C. § 78u-4(f)(2)(A) (2007). Given the

large market capitalizations of many companies in the

United States and the correspondingly large declines in

26

value following the announcement of disappointing news,

adoption of Petitioner’s proposed standard would create

the prospect that numerous manufacturers and other

third parties would face billions of dollars in potential

joint and several liability simply because they have done

business with a company that is accused of securities

fraud. The in terrorem effect of joint and several liability

further underscores the likely chilling effect of broad

scheme liability on domestic commerce.

This Court has long understood that “litigation under

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

degree and in kind from that which accompanies litigation

in general.” Blue Chip Stamps, 421 U.S. at 739. Over the

years, both Congress and this Court have taken steps to

mitigate this danger. In Blue Chip Stamps, for example,

the Court limited standing in private Rule 10b-5 actions to

purchasers and sellers of securities, citing the need for a

bright-line rule. See id. at 742. In Central Bank, the Court

dispensed with aiding and abetting liability in private

actions partly because it “exacts costs that may disserve

the goals of fair dealing and efficiency in the securities

markets.” Central Bank, 511 U.S. at 188. More recently, in

Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 346

(2005), the Court determined that plaintiffs must make a

meaningful showing of actual loss causation in order to

maintain a private right of action under Section 10(b).

Then, only a few weeks ago, the Court again raised the bar

for plaintiffs by elevating the scienter pleading standards

in many circuit courts. Tellabs, Inc., 127 S. Ct. at 2504-05.

Indeed, the Central Bank Court acknowledged the

very same kinds of costs that the NAM has pointed out here.

“(Ujncertainty and excessive litigation can have ripple

effects. ... [Nljewer and smaller companies may find it

difficult to obtain advice from professionals. A professional

27

may fear that a newer or smaller company may not

survive and that business failure would generate

securities litigation against the professional, among

others. In addition, the increased costs incurred by

professionals because of the litigation and settlement costs

under 10b-5 may be passed on to their client companies,

and in turn incurred by the company’s investors, the

intended beneficiaries of the statute.” 511 U.S. at 189

(emphasis added). Similarly, the uncertainties associated

with Petitioner’s scheme theory reduce the willingness of

companies to do business with one another, and the

massive litigation and settlement costs generated by

Petitioner’s theory ultimately get passed to consumers.

For its part, Congress enacted the Private Securities

Litigation Reform Act of 1995 (the “PSLRA”), Pub. L. 104-69,

109 Stat. 737 (Dec. 22, 1995) to curb these costs and

abuses, including “nuisance filings, targeting of deep-pocket

defendants, vexatious discovery requests, and ‘manipulation

by class action lawyers of the clients whom they

purportedly represent’... .” Dabit, 126 S.Ct. at 1510-11

(quoting H.R. Rep. No. 104-369,. p- 31-(1995))- In- addition

to imposing stringent pleading requirements, see 15 U.S.C.

§ 78u-4(b) (2007), the PSLRA reflected Congress’ tacit

approval of Central Bank’s bar on private aiding and

abetting liability. Cf 15 U.S.C. § 78t(e) (2007) (allowing

SEC enforcement against aiders and abettors but not

creating a private right of action). Moreover, when it

became apparent that plaintiffs were attempting to avoid

the PSLRA’s strictures by bringing securities fraud class

actions in state court, Congress enacted the Securities

Litigation Uniform Standards Act of 1998 (““SLUSA”), Pub.

L. 105-353, 112 Stat. 3227 (Nov. 3, 1998). See Dabit, 126

S. Ct. at 1511 (broadly construing SLUSA’s pre-emption

provisions to better effect the PSLRA’s goals).

28

To permit scheme liability would not only allow

Petitioner to circumvent Central Bank’s clear prohibition

on private aiding and abetting liability, but also would

undermine more than 30 years of carefully-crafted judicial

and congressional efforts to cabin frivolous securities fraud

litigation.

C. Section 10(b) Jurisprudence Should Not Be

Premised Upon A Search For Deep Pockets

Petitioner’s amici suggest that, because issuers that

engage in wrongdoing often are insolvent, outside actors

are the only potential defendants “with assets sufficient to

satisfy a judgment or fund a settlement... .” See, e.g.,

AARP Br. at 3. According to these amici, investors require

scheme liability to obtain adequate compensation. This

argument rests upon the explicit premise that, whatever

countervailing policy considerations might exist, “[nJone of

them is more important ... than the ability of defrauded

investors to recover their losses....” Jd. at 12. That

premise should be rejected.

Defrauded investors deserve redress, but their

remedies should not come at the expense of those who did

not violate the securities laws. Fairness — not a blind quest

for compensation - is the most important consideration,

and it is fundamentally unfair to craft Section 10(b)

jurisprudence around an indiscriminate search for deep

pockets. See Dura Pharmaceuticals, 544 U.S. at 345

(stating that it is not the goal of the securities laws “to

provide investors with broad insurance against market

losses”). It also is fundamentally unfair to impose massive

defense costs and liability on third parties simply because

they did business with a primary violator. Guilt by

association is not a reasonable or fair way to define the

scope of Section 10(b).

29

Indeed, if the Court adopts Petitioner’s proposed

“purpose and effect” test, it would permit issuers and their

officers and directors (i.e., those alleged to have actually

made misleading statements to shareholders) to seek

contribution from manufacturers and other companies

that did business with them. Were this to occur, securities

litigations would become even more complex and

expensive than they already are. Moreover, such third

party practice would tend to shift liability from the parties

who ordinarily are most central to any alleged fraud to

those with only a tangential relationship to the alleged

fraud simply because they have deeper pockets. Revising

the scope of Section 10(b) to compensate investors from the

coffers of any company that may have aided and abetted a

primary violation, as Petitioner and its amici advocate,

requires an act of Congress, not an expansion of an

implied right of action by the courts. See Jn re Charter

Comme'ns, Inc. Sec. Litig., 443 F.3d at 993 (a “decision[} of

this magnitude should be made by Congress[,}” if at all).

30

IV. CONCLUSION

For the reasons stated above, the judgment of the

Court of Appeals should be affirmed.

Respectfully submitted,

GEORGE M. NEWCOMBE

(Counsel of Record)

MICHAEL J. CHEPIGA

JAMES G. KREISSMAN

SIMONA G. STRAUSS

MICHAEL R. LIZANO

SIMPSON THACHER & BARTLETT LLP

2550 Hanover Street

Palo Alto, California 94304

(650) 251-5000

JAN S. AMUNDSON

Senior Vice President & General Counsel

QUENTIN RIEGEL

Vice President, Litigation & Deputy General Counsel

NATIONAL ASSOCIATION OF MANUFACTURERS

1331 Pennsylvania Avenue, NW

Washington, DC 20004-1790

(202) 637-3000

August 15, 2007