# 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%3A34

## Record

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

## Text

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385016_0280%3A34. Public record. Not legal advice.