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

SUPP No. 06-43

OFFICE OF THE CLERK

IN THE | SUPREME COURT, U.S.

tiie

ur 0A &. (2) EE

\

4

Supreme Court of the United 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 NORTH AMERICAN SECURITIES

ADMINISTRATORS ASSOCIATION, INC.,

AS AMICUS CURIAE IN SUPPORT OF PETITIONER

ALFRED E. T. RUSCH *

Senior Counsel

District of Columbia Securities Bureau

810 First Street, N.E.

Suite 701

Washington, D.C. 20002

(202) 442-7850

REX A. STAPLES

General Counsel of NASAA

STEPHEN W. HALL

Deputy General Counsel of NASAA

JOSEPH V. BRADY

Associate General Counsel of NASAA

LESLEY M. WALKER

Associate Counsel of NASAA

NORTH AMERICAN SECURITIES

* Counse! of Record ADMINISTRATORS ASSOCIATION, INC.

June 11, 2007

en

WiLSON-EPES PRINTING CO..INC. — (202) 789-0096 -— WASHINGTON, D.C. 20002

TABLE OF CONTENTS

TABLE OF ALT EBOIRE TE TESS .-.ccccccccoscosescczscssccscsscssonscese

INTEREST OF THE AMICUS CURIAE..........00000s00000s

SUMMARY OF THE ARGUMENT .............cccscsseeseeees

I.

THE RESPONDENTS CAN BE HELD

LIABLE UNDER SECTION 10(B) BECAUSE

THE SHAM BUSINESS TRANSACTIONS

THEY ENTERED INTO WERE “DECEP-

TIVE DEVICES” WITHIN THE MEANING

OF THE STATUTE; SECTION 10(B) WAS

WRITTEN TO ADDRESS DECEPTIVE

CONDUCT AS WELL AS MISREPRE-

SENTATIONS AND OMISSIONS ............020005

A.

The Plain Words of Section 10(b)

Encompass Deceptive Acts, Not Only

Misrepresentations and Omissions..............

The Legislative History of the Exchange

Act Makes Clear that Congress Intended

Section 10(b) as a Flexible, Catchall

Provision, to Be Applied to a Wide Variety

of Fraudulent Schemes ..................:sesssceeeees

SEC Rule 10b-5, Which Implements

Section 10(b), Covers a Wide Range of

Acts, Practices, and Schemes in Addition

to Untrue Statements and Omissions...........

The Decisions of this Court Support the

Application of Section 10(b) to Deceptive

Conduct Other than Misrepresentations

I ccacitnsnncsnctersiineninticintatiianieiineten

wf = EE:

10

ii

TABLE OF CONTENTS—Continued

Il. THE NEED TO PROTECT INVESTORS,

BOTH IN THIS CASE AND MORE

GENERALLY, SUPPORTS REVERSAL OF

THE LOWER COURT’S NARROW

INTERPRETATION OF SECTION 10(B).......

A. Section 10(b) Is to Be Applied Broadly

and Flexibly to Achieve its Objectives........

B. Congress and the Courts Regard Private

Actions Under Section 10(b) as an

Especially Important Mechanism for

Advancing the Goal of Investor Protection .

C. Allowing the Petitioner's Claims to

Proceed Will Further the Deterrent and

Remedial Goals of the Exchange Act..........

D. Giving Investors Fair Access to the Courts

Is Vital in Light of the Rise in Fraud, the

Statutory Limitations that Congress Has

Already Placed on Private Actions, and the

Lack of Alternative Remedies Under State

CCE EIOS crerescssnsasncsesenscciremvennescsmenentneninenenmnenenee

Page

18

18

19

21

22

27

ill

TABLE OF AUTHORITIES

CASES Page

| Affiliated Ute Citizens of Utah v. United States,

eee SED ecertteneiverinmenninnpsioteennvien 7

Basic Inc. v. Levinson, 485 U.S. 224 (1988) ...4, 8, 10, 19

Bateman Eichler, Hill Richards, Inc. v. Berner,

I cicinicininintcinieninscitinictetantinisanene 20

Blue Chip Stamps v. Manor Drug Stores, 421

Se ED seit ncininitsinnhustinideinteeciiiatadisiiiaiioen 6, 25

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

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

Chevron, U.S.A., Inc. v. NRDC, Inc., 467 U.S.

i Aiiiesiiicintiaiicdehiicienstainsiemiiiuddiadiiiaaneeiete 11

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

eis ssdiineeniictiinlntcainiiepaceesiiieiniemnniieeninies 20

Ernst & Ernst v. Hochfelder, 425 U.S. 185

ik iiencashinl lal eiaeta ching ucaaianiaaaednil 6, 7,9, 11

Herman & MacLean v. Huddleston, 459 U.S.

a cetininticnnsinisintiinnidiinnnnncnaneninnsineen 8, 13, 14

In re Charter Communications, Inc., Sec. Litig.,

443 F. 3d 987 (8th Cir. 2006), cert. granted,

127 S. Ct. 1873 (Mar. 26, 2007).............0c0s000 5, 13, 18

In re Charter Communications, Inc., Sec. Litig.,

No. MDL 1506, 4:02-SV-1186 CAS, 2004

WL 3826761 (E.D. Mo. Oct. 12, 2004)............. 17

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

Ee 15

JI. Case v. Borak, 377 U.S. 426 (1964).........:0006 25

Kaufman y. i-Stat Corp., 754 A.2d 1188 (N.J.

Ua ahcaeccnasssiuibinienniiesenisitebiapetenedsiabidiainemmmiepienies 26

Mirkin v. Wasserman, 858 P.2d 568 (Cal. 1993) .. 26

Peil v. Speiser, 806 F. 2d 1154 (3rd Cir. 1986)..... 25

Pinter v. Dahl, 486 U.S. 622 (1988)...............:0000. 19

iv

TABLE OF AUTHORITIES—Continued

Page

Regents of the Univ. of Calif. v. Credit Suisse

First Boston (USA), Inc., 482 F. 3d 372 (Sth

Re aT dis tisnid dinitiinerniesianinacsinitesteintiamneaniaineneeen 16

Santa Fe Industries, Inc. v. Green, 430 U.S. 462

Ie aiistaiiadiinhinhisiectictinietnniietadnenibiesangnennensents 16, 17, 25

SEC v. Capital Gains Research Bureau, Inc., 375

Se TE iicsitiniianiiidbbihiecisiadsneesisintiinesecewontes 8

SEC v. Zandford, 535 U.S. 813 (2002).............0+0+ 11,19

SEC v. W.J. Howey Co., 328 U.S. 293 (1946)....... 10, 19

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

EEN SENET icniatnsisesinncsenansinicnnscindinntecseen 14, 15

Small v. Fritz Cos., Inc., 65 P. 3d 1255 (Cal.

ait itisishsonipsitiinsistadinaduendidonabenimniicnmateeiieenenieanes 26

Superintendent of Insurance v. New York, 404

Tt tbitididnaanntncensncatidesiniendigunens 12

STATUTES AND RULES

i icinrnictssinccssnnneenssnenenaniisinite 13

BT ius iciicrcicisneucimmenetecinnandsnenesseton 7

i cninricnnsatecnsnintescennsdeniesinnnnnnnns 25

cin dininccenisinnartnedicisinnneneninttes 7

Be i ciicnncsiscaneptnnienasesisnnsesinneninns 13

BE isrnsiessenseecusssncencccensesssesorentestecios passim

TT tori niicscgnncssatenseenscsssquamenenemanenta 21

Be ee I PUI vncscncencsccsedsccsscenssccesnnscennsies 23

ee I ccsircnseenncscecmnisemsectineneenncnsscenen 23

init aniniuetnecnieteenttibinincininn 23

I riclisiricricepcnminsctemenidaiusennbesenions 25

ee INO ccncescncsscssesnensscnsenstansemenncetedin passim

STITT ITI iecttiscutisininsnieiimenisnnpnietantinianiiciinneendie 2

8 ERT ae ne a Te 1

Vv

TABLE OF AUTHORITIES—Continued

LEGISLATIVE HISTORY

Hearing on H.R. 5491, Before the House

Committee on Financial Services, Subcom-

mittee on Capital Markets, Insurance, and

Government Sponsored Enterprises, 109th

Cong. (2006) (Statement of James D. Cox),

available at www.law.duke.edu/features/pdf/

H.R. REP. No. 73-1383 (1934), 1934 WL 1290...

H.R. Rep. No. 107-414 (2002), 2002 WL

OTHER AUTHORITIES

Brief of the North American Securities Admin-

istrators Association, Inc., as Amicus Curiae,

in Support of Respondents, filed in Tellabs,

Inc. v. Makor Issues & Rights, Ltd., Case No.

06-484 (U.S. Mar. 9, 2007), available at http://

www.nasaa.org/content/Files/Tellabs.pdf .........

Brief of the North American Securities Admin-

istrators Association, Inc., as Amicus Curiae,

in Support of the People of the State

California, in People v. Edward D. Jones &

Co., Case No. CO53407 (Cal. Ct. App. Feb.

23, 2007), available at http://www.nasaa.org/

content/Files/ED_JONES_FINAL.pdf..............

Joel Seligman, Rethinking Private Securities

Litigation, 73 U. Cin. L. Rev. 95 (2004)...........

vi

TABLE OF AUTHORITIES—Continued

Kevin S. Schmelzer, The Door Slammed Shut

Needs to be Reopened: Examining the Plead-

ing Requirements Under the Private Securities

Litigation Reform Act, 78 Temp. L. Rev. 405

Press Release, No. 2002-179, SEC, NY Attorney

General, NASD, NASAA, NYSE and State

Regulators Announce Historic Agreement to

Reform Investment Practices (SEC, Dec. 20,

2002), available at http://www.sec.gov/news/

III teecccicnscnssnentsocsensccsssnrenseeseses

Press Release, State Investigation Reveals

Mutual Fund Fraud (Office of the New York

Attorney General, Sept. 3, 2003), available at

http://www.oag.state.ny.us/press/2003/sep/sep

I ih ciertatesederetcsiesseenenstenncontnmnesennnsnssenees

Robert A. Prentice, Locating that “Indistinct”

and “Virtually Nonexistent” Line Between

Primary and Secondary Liability Under

Section 10(b), 75 N.C. L. Rev. 691 (1997)........

Ronald I. Miller, Todd Foster, and Elaine

Buckberg, Recent Trends in Shareholder Class

Action Litigation: Beyond the Mega-Settle-

ments, is Stabilization Ahead? Apr. 2006,

available at http://www.nera.com/image/BRO

_RecentTrends2006 SEC979_PPB-FINAL.pdf

(National Economic Associates, Inc.) ...............

WEBSTER’S NEW WORLD DICTIONARY (3rd ed.

Page

24

23

8, 10

24

IN THE

Supreme Court of the United States

No. 06-43

STONERIDGE INVESTMENT PARTNERS, LLC,

Petitioner,

Vv.

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 NORTH AMERICAN SECURITIES

ADMINISTRATORS ASSOCIATION, INC.,

AS AMICUS CURIAE IN SUPPORT OF PETITIONER

INTEREST OF THE AMICUS CURIAE

The North American Securities Administrators Associa-

tion, Inc. (““NASAA”), is the nonprofit association of state,

provincial, and territorial securities regulators in the United

States, Canada, and Mexico. It has 67 members, including

the securities regulators in <.i 50 states, the District of

Columbia, Puerto Rico, and the U.S. Virgin Islands. Formed

in 1919, it is the oldest international organization devoted to

protecting investors from fraud and abuse in connection with

the offer and sale of securities. '

' Pursuant to Sup. CT. R. 37.6, NASAA represents that no counsel for

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

other than NASAA, its members, or its counsel, made any monetary con-

2

The U.S. members of NASAA are responsible for admin-

istering state securities laws and regulations. Their activities

include licensing broker-dealers, registering local securities

offerings, and conducting compliance examinations. Espe-

cially important is their enforcement role: protecting the

nation’s investors by bringing literally thousands of enforce-

ment actions every year against the firms and individuals who

have committed fraud and abuse in connection with the

sale of securities. In those cases, state securities regulators

often seek restitution to help make injured investors whole,

although the best hope of recovery for the vast majority of

defrauded investors is through the courts in private actions for

damages, not through governmental enforcement actions at

either the state or federal level.

NASAA supports the work of its members through training

programs, enforcement assistance, and legislative analysis.

Another important role of the association is representing the

membership’s position as amicus curiae in significant cases

brought by private plaintiffs as well as government regulators

involving the interpretation of the securities laws and the

rights of investors. See, e.g., Brief of the North American

Securities Administrators Association, Inc., as Amicus Curiae,

in Support of Respondents, filed in Tellabs, Inc. v. Makor

Issues & Rights, Lid., Case No. 06-484 (U.S. Mar. 9, 2007)

(supporting investors’ position on the “strong inference of

scienter” standard under the Private Securities Litigation

Reform Act), available at http://www.nasaa.org/content/

Files/Tellabs.pdf; Brief of Amicus Curiae North American

Securities Administrators Association, Inc., in Support of the

People of the State of California, filed in People v. Edward D.

tribution to the preparation or submission of the brief. Pursuant to Sup.

Cr. R. 37.3, NASAA further represents that all parties to this appeal

have consented to the filing of this amicus brief. The Petitioner’s written

consent is on file with the Court, and the Respondents’ written consent

accompanies this brief.

3

Jones & Co., Case No. CO53407 (Cal. Ct. App. Feb. 23,

2007), available at http://www.nasaa.org/content/Files/ED _

JONES _FINAL.pdf.

NASAA and its members have an interest in the outcome

of this appeal because it will profoundly affect the ability

of investors to seek redress in cases where unscrupulous

companies and individuals have actively participated with

issuers in schemes to defraud the securities markets. The

Eighth Circuit incorrectly held that any defendant who does

not make a fraudulent misstatement or omission, or who does

not engage in manipulative trading of securities, cannot be

held liable as a primary violator of Section 10(b) of the

Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C.

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

§ 240.10b-5. The lower court adopted the narrow view that

absent those specific forms of misconduct, a defendant is at

most an aider and abettor immune from suit under Central

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

511 U.S. 164 (1994). If this Court affirms the lower court

and thus insulates a broad range of deceptive practices from

the reach of Section 10(b), many victims of securities fraud

with meritorious claims will lose the opportunity to recover

damages resulting from undeniably culpable behavior. As

advocates for the rights of investors to seek redress, NASAA

and its members have an interest in supporting reversal and

restoring an interpretation of the law that is more in keeping

with its language, intent, and underlying purposes.

This Court’s decision will also have a pivotal effect on the

role of private actions as a deterrent against securities fraud.

Private actions by defrauded investors are an enormously

important complement to regulatory enforcement actions as

a means of policing the securities marketplace. State and

federal securities regulators work tirelessly to detect, enjoin,

and punish financial fraud. However, private actions not only

provide the principal means of compensation for victims of

4

securities fraud, they also play a vitally important role in

protecting the integrity of the marketplace through deterrence,

a fact often noted by this Court. See, e.g., Basic Inc. v.

Levinson, 485 U.S. 224, 230-31 (1988) (the private cause of

action for violations of Section 10(b) and Rule 10b-5 con-

stitutes an “essential tool for enforcement of the 1934 Act’s

requirements”). The burgeoning growth in large-scale secu-

rities fraud over the past decade shows that a broad inter-

pretation of Section 10(b), in keeping with its remedial

purposes, is just as important today as it was in 1934, perhaps

more so. To the extent that the Court erects unwarranted

barriers to recovery in private actions—such as immunity for

those who participate in fraudulent schemes through decep-

tive acts, not words—the Court will undermine an important

deterrent that benefits the marketplace as a whole. For this

additional reason, NASAA and its members support reversal

of the circuit court’s decision.

SUMMARY OF THE ARGUMENT

The lower court erred when it dismissed the Petitioner’s

claims and held that Section 10(b) of the Exchange Act and

Rule 10b-5 encompass only misstatements and omissions of

material fact and not deceptive acts performed as part of a

scheme to defraud the securities markets. The lower court’s

narrow construction conflicts with the plain language of the

statute, Congress’s intent that the antifraud provisions of the

Exchange Act be construed broadly, and this Court’s deci-

sions recognizing that Section 10(b) applies to deceptive

actions as well as misstatements and omissions.

The lower court also erred by ignoring the public policy

implications of its interpretation of the law. The boundless

ingenuity of those who commit fraud and the need to protect

investors from fraud and abuse together make it imperative

that Section 10(b) be applied to all types of deceptive devices.

A decision that holds all parties accountable for their role in a

5

fraudulent scheme—tregardless of whether their deception

was perpetrated through words or deeds—will help repair the

damage done to investors and deter future violations, without

unduly burdening the legitimate industry. At a time when

large scale financial fraud shows little sign of abating, this

Court should ensure that injured investors have the oppor-

tunity to seek relief in federal court. For these reasons, the

Court should reverse the lower court’s decision and reinstate

the Petitioner’s claims.

ARGUMENT

I. THE RESPONDENTS CAN BE HELD PRI-

MARILY LIABLE UNDER SECTION 10(B)

BECAUSE THE SHAM BUSINESS TRANS-

ACTIONS THEY ENTERED INTO WERE

“DECEPTIVE DEVICES” WITHIN THE

MEANING OF THE STATUTE; SECTION 10(B)

WAS WRITTEN TO ADDRESS DECEPTIVE

CONDUCT AS WELL AS MISREPRESEN-

TATIONS AND OMISSIONS OF MATERIAL

FACT

Section 10(b) of the Exchange Act applies to the deceptive

business transactions that the Respondents entered into with

Charter Communications, Inc. (“Charter”) to perpetrate a

fraud on the securities market. The lower court held to

the contrary and dismissed the Petitioner’s claims, ruling that

“[{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.” Jn re Charter

Communications, Inc., Sec. Litig., 443 F. 3d 987, 992 (8th

Cir. 2006), cert. granted, 127 S. Ct. 1873 (Mar. 26, 2007).

The lower court erred. The plain language of the statute,

its legislative history, and the decisions of this Court all show

that Section 10(b) encompasses deceptive conduct as well

as misstatements and omissions. Moreover, Section 10(b)

6

applies to any person that has used a deceptive device to

perpetrate a fraud, regardless of whether that person is a

corporate insider, an accountant, or simply an outside

business partner. In this case, the Respondents participated in

sham business transactions that had no economic purpose

other than artificially inflating Charter’s revenues and its

stock price. Even if the Respondents did not publicly dis-

seminate false statements reflecting those transactions, their

deceptive conduct led to the same result—a fraud on the

market. By virtue of these acts, the Respondents used

“deceptive devices” within the meaning of Section 10(b).

Accordingly, they should be held accountable as primary

violators in a trial on the merits.

A. The Plain Words of Section 10(b) Encompass

Deceptive Acts, Not Only Misrepresentations

and Omissions

The lower court’s narrow interpretation of Section 10(b) is

not consistent with the plain language of the Exchange Act.

The primary guide to the meaning of any statute is the lan-

guage of the statute itself. See Blue Chip Stamps v. Manor

Drug Stores, 421 U.S. 723, 756 (1975) (Powell, J., concur-

ring). This Court evaluates both the literal meaning of

the words used in a statute, as well as their connotation, to

ascertain Congress’s intent. See Ernst & Ernst v. Hochfelder,

425 U.S. 185, 199 & n.20 (1976) (relying upon definitions

and connotations of the words “device,” “contrivance,” and

“manipulate” as the basis for its holding that Section 10(b)

requires some degree of scienter). In this case, the wording

of Section 10(b) plainly covers a broad spectrum of conduct

in addition to misrepresentations and omissions. Congress

made it unlawful for “any person, directly or indirectly, . . . to

use or employ, . . . any manipulative or deceptive device or

contrivance” in contravention of the SEC’s rules and regu-

lations. 15 U.S.C. § 78j(b) (en.phasis added). The words

“use,” “employ,” “device,” and “contrivance” all have inher-

7

ently nonverbal definitions and connotations. Cf Ernst &

Ernst, 425 U.S. at 199 n.20. Further, the word “deceive”

“implies deliberate misrepresentation of facts” by “actions” as

well as “words.” See WEBSTER’S NEW WORLD DICTIONARY

(3rd ed. 1986). Congress’s repeated use of the word “any” is

another clear indication that the provision was intended to be

broad and “inclusive.” Affiliated Ute Citizens of Utah v.

United States, 406 U.S. 128, 151 (1972). Congress had no

intention of limiting its comprehensive ban on fraud in

Section 10(b) to strictly verbal utterances.

Congress’s choice of more limited wording in other anti-

fraud provisions of the securities laws underscores the

intended breadth of Section 10(b). Cf Ernst & Ernst v.

Hochfelder, 425 U.S. at 206 (observing that the 1933 and

1934 Acts are interrelated components of a federal regulatory

scheme, and comparing various provisions to ascertain Con-

gressional intent with respect to scienter). For example, in

Section 12(a)(2) of the Securities Act of 1933, Congress

established civil liability for very a carefully defined type of

fraud. The provision targets the offer or sale of a security “by

means of a prospectus or oral communication, which includes

an untrue statement of a material fact or omits to state a

material fact necessary in order to make the statements, in

light of the circumstances in which they were made, not

misleading ...” 15 U.S.C. § 77Ka)(2). Obviously, Congress

knew how to target misrepresentations and omissions alone

when it wanted to do so, and it is appropriate to infer that

Congress intended something distinctive and broader in

Section 10(b).

The legal context in which Congress drafted Section 10(b)

also supports imposition of liability upon all those who

participate in a fraudulent scheme through actions or words.

The Exchange Act was intended not only to preserve all

rights and remedies under the common law, but to strengthen

those standards of conduct. See 15 U.S.C. § 78bb(a) (rights

and remedies provided under statute are in addition to “any

and all other rights and remedies that may exist at law or in

equity”); Basic Inc. v. Levinson, 485 U.S. 224, 244 n.22

(1988) (Rule 10b-5 actions were intended “to add to pro-

tections provided investors under the common law”); Herman

& MacLean v. Huddleston, 459 U.S. 375, 388 (1983) (“im-

portant purpose of the federal securities acts was to rectify

perceived deficiencies in the available common law remedies

by establishing higher standards of conduct in the securities

industry”). One of the attributes of the common law in 1934

was liability for those who participated in a fraud. See Robert

A. Prentice, Locating that “Indistinct” and “Virtually Non-

existent” Line Between Primary and Secondary Liability

Under Section 10(6), 75 N.C. L. Rev. 691, 753 (1997), and

cases cited therein at nn.266 & 267 (the common law was

very clear in holding that all participants in a fraudulent

scheme—not just those who had direct contact with the

victim—were liable to the scheme’s victims). Given the

Congressional desire to improve upon available remedies,

Section 10(b) deserves an interpretation at least as broad

as the common law doctrines prevailing at the time of

enactment. By this measure, all participants in a fraudulent

scheme who engage in deception can be held primarily liable.

Although the Court in Central Bank rejected a similar

analysis as to aiding and abetting liability under Section

10(b), it did so because largely because it questioned whether

aiding and abetting was really part of the common law. See

Central Bank, 511 U.S. at 181-82. The Court did not, how-

ever, reject the general principle that, absent direct conflict

with statutory language, the jurisprudence of Section 10(b)

should be informed by the common law. Cf SEC v. Capital

Gains Research Bureau, Inc., 375 U.S. 180, 195 (1963)

(broad interpretation of the antifraud provisions in the

Investment Advisers Act is supported by an evolution in the

common law of fraud to encompass breach of fiduciary duty

in securities transactions). In this case, there is no uncertainty

9

that the common law of fraud historically attached primary

liability to all of the participants in a fraudulent scheme.

B. The Legislative History of the Exchange Act

Makes Clear that Congress Intended Section

10(b) as a Flexible, Catchall Provision, to Be

Applied to a Wide Variety of Fraudulent

Schemes

The legislative history of the Exchange Act, although not

extensive with respect to Section 10(b), supports a broad

reading of the provision, one that covers a wide range of

manipulative and deceptive conduct. The legislative reports

describe the purpose of the law in terms of prohibiting

“inequitable and unfair practices.” See, e.g., S. REP. No. 73-

792 (1934), 1934 WL 1289, at *1, *6 (also explaining that

statute was aimed at “manipulative and deceptive practices”).

Nowhere in the legislative history is there any language stat-

ing or suggesting that Section 10(b) was intended to cover

only misstatements and omissions. Under this Court’s deci-

sions interpreting Section 10(b), the absence of such legisla-

tive history is a significant reflection of Congress’s intent.

See Ernst & Ernst, 425 U.S. at 202 (noting the absence of any

legislative history supporting a negligence standard).

The legislative history also reveals that Congress intended

Section 10(b) to be a “catchall” provision that would give the

SEC authority to deal with “new manipulative devices.” See

Ernst & Ernst, 425 U.S. at 202 (quoting testimony); see also

H. REP. No. 73-1383 (1934), 1934 WL 1290, at *6-7 (“In a

field where practices constantly vary and where practices

legitimate for some purposes may be turned to illegitimate

and fraudulent means, broad administrative powers in the

administrative agency have been found practically essential

.... ). This Court’s decisions reflect the same point: inter-

pretations of the securities laws must be “capable of adapta-

tion to meet the countless and variable schemes devised by

10

those who seek the use of the money of others on the promise

of profits.” See SEC v. W.J. Howey Co., 328 U.S. 293, 299

(1946).

The constantly evolving nature of the securities markets

and the need for a corresponding flexibility in the law has

also influenced the Court’s application of Section 10(b) in

private civil actions. In Basic Inc. v. Levinson, the Court

adopted a flexible approach to the element of reliance, allow-

ing it to be presumed where a fraud has affected the market

price upon which buyers and sellers rely. 485 U.S. 224, 247.

The Court stated: “The modern securities markets, literally

involving millions of shares changing hands daily, differ from

the face-to-face transactions contemplated by early fraud cases,

and our understanding of Rule 10b-5’s reliance requirement

must encompass these differences.” Jd. at 243-44. In the

words of the House Report:

As a complex society so diffuses and differentiates the

financial interests of the ordinary citizen that he has to

trust others and cannot personally watch the managers of

all his interests . . . it becomes a condition of the very

stability of that society that its rules of law and of

business practice recognize and protect that ordinary

citizen’s dependent position.

See Prentice, 75 N.C. L. Rev. at 715-16 (quoting H. Rep. No.

73-1383, at 5 (1934)). The complex securities fraud alleged

in this case illustrates the need to apply the law flexibly, as

Congress intended.

C. SEC Rule 10b-5, Which Implements Section

10(b), Covers a Wide Range of Acts, Practices,

and Schemes in Addition to Untrue Statements

and Omissions

The interpretation of the regulatory agency charged with

implementing Section 10(b) supports a broad reading of the

statutory language. The SEC adopted Rule 10b-5 in accor-

1]

dance with the Congressional directive set forth in Section

10(b). While subsection (b) of the Rule focuses exclusively

on “untrue statements” and “omissions” of material fact, the

other two subsections address much broader conduct, making

it unlawful “to employ any device, scheme, or artifice to

defraud,” 17 C.F.R. § 240.10b-5(a), or “to engage in any act,

practice, or course of business which operates or would

operate as a fraud or deceit,” 17 C.F.R. § 240.10b-S(c).

Subsections (a) and (c}—also promulgated in accordance

with Section 10(b)}—address fundamentally broader types of

fraud than the more narrowly written provisions of subsection

(b) dealing with misrepresentations and omissions. It is true

that the Rule cannot be read to cover more than what Con-

gress intended to reach in Section 10(b) of the Exchange Act,

because the SEC’s rule making authority was circumscribed

by the ambit of the statutory provision it was interpreting.

See Ernst & Ernst, 425 U.S. at 213. However, the very broad

language that Congress used to frame Section 10(b) left

ample room for all of the unlawful activities enumerated in

subsections (a) through (c) of Rule 10b-5. The SEC’s Rule

was therefore a reasonable and appropriate explication of the

intended scope of the statute and as such, it deserves

deference. See Chevron, U.S.A., Inc. v. NRDC, Inc., 467 U.S.

837, 843-44 (1984).

D. The Decisions of this Court Support the

Application of Section 10(b) to Deceptive

Conduct Other than Misrepresentations and

Omissions

The decisions of this Court support a finding that the ©

phrase “deceptive devices” as it appears in Section 10(b)

includes fraudulent acts, as well as misrepresentations and

omissions. For example, in SEC v. Zandford, 535 U.S. 813

(2002), a client opened an investment account with a broker,

for himself and his mentally retarded daughter. /d at 815.

Over a two year period, the broker engaged in a pattern of

12

selling the securities in the account and converting the

proceeds for his own use. /d. at 815, 820. The focus of the

Court’s opinion was that the fraud occurred “in connection

with the purchase or sale of [a] security,” but the Court also

held that the combined actions of selling the securities and

converting the proceeds constituted a deceptive device under

Section 10(b) and Rule 10b-5. The Court noted that the

scheme was not authorized or disclosed to the client, but the

Court viewed the conduct itself as sufficient to trigger

application of Section 10(b) and the Rule: “Indeed, each time

respondent ‘exercised his power of disposition for his own

benefit,’ that conduct, ‘without more,’ was a fraud.” Jd at

821 (citation omitted).

The Court in Zandford also dismissed the argument that the

sale of securities and the conversion of fumds were indepen-

dent events. The Court found that the two elements of the

scheme were sufficiently linked to support application of

Section 10(b) because the sales were effected for the ultimate

purpose of converting the proceeds. /d. at 820. Similarly in

this case, the Respondents engaged in deceptive business

transactions for the ultimate purpose of creating fictitious

revenues on Charter’s books and shoring up Charter’s stock

price. Under the reasoning in Zandford, such deceptive

devices fall within the scope of Section 10(b).

In Superintendent of Insurance v. State of New York, 404

U.S. 6 (1971), the Court held that Section 10(b) and Rule

10b-5 were applicable to an elaborate scheme in which the

defendants sold $5,000,000 worth of securities held by an

insurance company, misappropriated the proceeds, and con-

cealed the fraud in the company’s books and records. The

Court stated that the company “was injured as an investor

through a deceptive device which deprived it of any com-

pensation for the sale of its valuable block of securities.” /d.

at 10. Further emphasizing that the scheme was implemented

largely through a series of fraudulent acts, not just misrep-

13

resentations, the Court observed: “The crux of the present

case is that Manhattan suffered an injury as a result of

deceptive practices touching its sale of securities as an

investor.” Jd. at 12-13. The Court was unconcerned that

the “fraud was perpetrated by an officer of the corporation

and his outside collaborators,” id. at 10 (emphasis added),

because Section 10(b) “bans the use of any deceptive device

in the ‘sale’ of any security by ‘any person,” id.”

This Court’s decision in Herman & MacLean v. Huddleston,

459 U.S. 375 (1983), also supports an interpretation of

Section 10(b) that extends it to deceptive acts other than

misrepresentations and omissions. In Herman, the Court held

that a private action lies under Section 10(b) notwithstanding

the availability of a remedy under Section 11 of the Securities

Act of 1933, 15 U.S.C. § 77k, which prohibits false or

misleading information in registration statements. /d. at 387.

The Court observed that although Section 10(b) and Section

11 may overlap to some degree, they largely address different

types of wrongdoing. Jd. at 382. The Court emphasized that

Section 11 could be invoked only against certain parties and

only for fraud in registration statements. Jd The Court

? The Superintendent case, coupled with the broad wording of Section

10(b), disposes of the lower court’s suggestion that outside business part-

ners engaged in “arms-length” transactions with issuers cannot be held

primarily liable under the statute. See In re Charter Communications,

Inc., 443 F. 3d at 991, 992. Section 10(b) covers “any person” using de-

ceptive devices, and the Exchange Act defines the term “person” expan-

sively. See 15 U.S.C. 78c(a)(9). It does not limit liability to corporate

insiders or professional consultants that have special duties to the com-

pany. Even this Court’s decision in Central Bank recognized the potential

liability of outside entities under Section 10(b). It cautioned that the

elimination of aiding and abetting liability did not insulate all secondary

actors from primary liability under Section 10(b), and noted that “any

person or entity” may be liable, provided all the requirements of the stat-

ute and the Rule are met. Central Bank of Denver, N.A., 511 U.S. at 191.

The Court cited lawyers, accountants, and banks as examples, but not as

an exhaustive enumeration of potentially liable secondary actors. /d

14

explained that Section 10(b) was, “[i]n contrast,” a “catchall”

antifraud provision, under which “action can be brought by a

purchaser or seller of ‘any security’ against ‘any person’ who

has used ‘any manipulative or deceptive device or contriv-

ance” in connection with the purchase or sale of a security.”

Id. at 382 (emphasis in original) (citations omitted).

The Court further explained that limiting the scope of Sec-

tion 10(b) would immunize any parties—such as corporate

officers, lawyers, and accountants—who did not prepare or

certify the registration statements but who nevertheless may

have engaged in “fraudulent conduct while participating in

the registration statement.” Jd. at 387 n.22 (emphasis added).

In the Court’s view, such a result would conflict with the

plainly broad language of Section 10(b), and with the rule

that securities laws combating fraud should be construed

broadly to achieve their remedial purposes. Jd. at 387-88. In

keeping with the decision in Herman and Congress’s legisla-

tive intent, this Court should not immunize parties such as the

Respondents, who may not have issued Charter’s false finan-

cial reports, but who nevertheless participated in the devel-

opment of those reports through fraudulent conduct.

Some lower federal courts have endorsed the application of

Section 10(b) to deceptive conduct as well as misrepresen-

tations and omissions. In Simpson v. AOL Time Warner, Inc.,

452 F. 3d 1040 (9th Cir. 2006), the investors alleged that an

internet-based real estate company engaged in complex

“barter” or “round-trip” transactions with its business clients

for the purpose of inflating its revenues. /d at 1043. The

Ninth Circuit Court of Appeals articulated the following test

for determining whether a defendant may be held liable as a

primary violator of Section 10(b): “If a defendant’s conduct

or role in an illegitimate transaction has the principal purpose

and effect of creating a false appearance of fact in the fur-

therance of a scheme to defraud, then the defendant is using

or employing a deceptive device within the meaning of

15

§ 10(b).” Jd. at 1050. The court explained that in contrast,

“participation in a legitimate transaction, which does not have

a deceptive purpose or effect, would not allow for a pri-

mary violation, even if the defendant knew or intended that

another party would manipulate the transaction to effectuate a

fraud.” Jd.

_The court emphasized the importance of examiris.g “the

deceptive nature of the defendant’s own conduct” as a means

of differentiating primary violators from mere aiders and

abetters, who cannot be found liable under Section 10(b). Jd.

at 1049. The court ultimately dismissed the complaint, with

leave to seek amendment, because the allegations failed ade-

quately to aver that the business client’s transactions were

illegitimate or had created false appearance of fact. Jd at

1052-53. However, the court’s analysis nevertheless demon-

strated that applying Section 10(b) to deceptive conduct is at

least one principled way of attaching primary liability to

those who participate in a fraudulent scheme, while at the

same time respecting this Court’s prohibition against aiding

and abetting liability under Central Bank. See also In re

Lernout & Hauspie Sec. Litig., 236 F. Supp. 2d 161, 173 (D.

Mass. 2003) (denying a motion to dismiss for outside busi-

ness partners who devised sham corporate entities to hide

expenses and overstate profits).°

In this case, of course, the Respondents’ transactions with

Charter were not legitimate and they undoubtedly created a

false appearance: that the surcharge for each cable box was a

> The court in Simpson also correctly held that the required element of

reliance is present in deceptive conduct cases “if the introduction of

misleading statements into the securities market was the intended end

result of a scheme to misrepresent revenue.” 452 F. 3d at 1051. In this

case, the introduction of false revenue reports into the marketplace was

the intended result of the Respondents’ scheme, so the element of reliance

is present.

16

capital expense, and that the return of the surcharge to Char-

ter in the guise of advertising fees was genuine revenue.

Accordingly, the Respondents used deceptive devices within

the meaning of Section 10(b). But see Regents of the Univ. of

Calif. v. Credit Suisse First Boston (USA), Inc., 482 F. 3d

372, 388 (Sth Cir. 2007) (disagreeing with the Ninth Circuit’s

approach in Simpson and holding that deception within the

meaning of Section 10(b) is limited to a misstatement or a

failure to disclose by one who has a duty to disclose).

The lower court in this case relied upon Central Bank and

Santa Fe Industries, Inc. v. Green, 430 U.S. 462 (1977), as

the basis for its narrow reading of Section 10(b), but in

neither of those cases did this Court restrict the application of

Section 10(b) to misstatements and omissions. In Central

Bank, the Court held that the text of Section 10(b) “does

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

See 511 U.S. at 177. In dicta, the Court paraphrased the

broad language of Section 10(b) as a prohibition against

“the making of a material misstatement (or omission) or the

commission of a manipulative act.” /d at 177. This isolated

observation was not an element of the Court’s holding, and it

was contradicted by other language in the opinion more

accurately characterizing Section 10(b) in terms of “manipu-

lative or deceptive acts.” Jd. at 177-178.

Nor does Santa Fe stand for the proposition that Section

10(b) is confined to misstatements and omissiors. In Santa

Fe, minority shareholders alleged they had received under-

valued stock from majority shareholders during a merger.

The majority shareholders had fully complied with the appli-

cable state merger law, and had fully disclosed the terms of

the merger, including the share price and the method used for

its computation. 430 U.S. at 466, 469. The Court affirmed

dismissal of the complaint, holding that a breach of fiduciary

duty by itself, without any deception of any kind, did not

comprise a violation of 10(b). Jd. at 475-76. In the words of

17

the Court, “We thus adhere to the proposition that ‘Congress

by § 10(b) did not seek to regulate transactions which con-

stitute no more than internal corporate mismanagement.” Jd.

at 479 (citation omitted). Although the Court ruled that some

form of deception is an essential element of a claim under

Section 10(b), the Court also quite clearly understood the

concept of deception in a broad sense, one that allowed for

deceptive conduct as distinct from misstatements and omis-

sions. For example, in rejecting the plaintiffs’ contention, the

Court observed that “The cases do not support the proposition

. . . that a breach of fiduciary duty by majority shareholders,

without any deception, misrepresentation, or nondisclosure,

violates the statute and the Rule.” Jd at 476 (emphasis

added); see also id. at 473 (“The language of § 10(b) gives no

indication that Congress meant to prohibit any conduct not

involving manipulation or deception.”) (emphasis added).

All of the foregoing authorities confirm that the plain

language and the intended scope of Section 10(b) is broad

enough to encompass the Respondents’ conduct in this case.

The sham transactions they entered into with Charter were

“deceptive devices” because they created the false impression

that Charter was making bona fide capital expenditures and

receiving bona fide revenues in its transactions with the

Respondents. In fact, the arrangement had no financial sig-

nificance whatsoever. Moreover, the Respondents engaged in

the deceptive scheme for the ultimate purpose of artificially

inflating the market price of Charter’s stock, to the detriment of

public shareholders. The allegations against the Respondents in

this case therefore describe the use of “deceptive devices” to

commit securities fraud, in violation of Section 10(b). *

“In this case, although the Respondents did not engage in wash sales

on an exchange, they did enter into what can certainly be described as

“wash” business transactions that had the specific purpose and effect of

generating fictitious revenue reports that in tum artificially supported the

market price of Charter’s shares. See In re Charter Communications, Inc.,

18

II. THE NEED TO PROTECT INVESTORS, BOTH

IN THIS CASE AND MORE GENERALLY,

SUPPORTS REVERSAL OF THE LOWER

COURT’S NARROW INTERPRETATION OF

SECTION 10(B)

The lower court based its decision in part on considerations

of public policy. The court asserted that imposing liability on

the Respondents for deceptive conduct would “introduce

potentially far-reaching duties and uncertainties for those

engaged in day-to-day business dealings,” a policy decision

that the court viewed as a matter best left to Congress. In re

Charter Communications, Inc., 443 F. 3d at 992-93. The

lower court’s concerns were unfounded. Applying Section

10(b) to the type of deceptive business deals that the Respon-

dents entered with Charter will impose no duties or uncertain-

ties, other than those that arise from the universal and entirely

fitting obligation to refrain from using deceptive devices in

schemes to commit securities fraud. Even more important

is the lower court’s failure to consider any of the investor

protection policies underlying the securities acts. Those

interests justify a broad reading of Section 10(b), not a

restrictive interpretation that immunizes participants in a

securities fraud.

A. Section 10(b) Is to Be Applied Broadly and

Flexibly to Achieve its Objectives

Congress passed the Exchange Act in 1934 as part of an

aggressive legislative response to extensive fraud and abuse

in the securities markets. The overriding purpose of the

Sec. Litig, No. MDL 1506, 4:02-SV-1186 CAS, WL 3826761, at *3 (E.D.

Mo. Oct. 12, 2004) (“the price increases paid by Charter and ‘advertising

payments’ made by the vendors constituted ‘wash’ transactions with no

economic significance”). The Respondents were full and witting partners

in these deceptive transactions and were therefore primary actors in the

fraudulent scheme.

19

statute is to protect investors, and since 1934, this Court

has declared again and again that the federal securities laws

should be interpreted broadly and flexibly to achieve that

remedial purpose. See generally SEC v. Zandford, 535 U.S.

813, 819 (2002). Applying this rule of statutory construction

in the securities field, the Court has expansively interpreted

many facets of Section 10(b): the misconduct that it prohibits,

the securities that trigger its application, and the elements of a

violation. See SEC v. Zandford, 535 U.S. 813 (applying

Section 10(b) to sale of client’s securities and conversion of

proceeds); Basic Inc. v. Levinson, 485 U.S. 224 (1988) (reject-

ing narrow interpretation of materiality with respect to merger

negotiations and recognizing a presumption of reliance in

cases involving fraud on the market); SEC v. W.J. Howey Co.,

328 U.S. 293 (1946) (broadly defining investment contracts

as securities).

B. Congress and the Courts Regard Private

Actions Under Section 10(b) as an Especially

Important Mechanism for Advancing the Goal

of Investor Protection

In these and other decisions, the Court has recognized a

strong Congressional policy favoring private actions as a

means of achieving the investor protection goals underlying

the securities laws. Private actions afford victims of fraud the

best and often only hope of recovering their losses—

something government enforcement actions are ill-equipped

to do on a large scale. Private actions are also an essential

deterrent because governmental enforcement program simply

cannot, by themselves, inspire compliance with the law. See

generally Pinter v. Dahl, 486 U.S. 622, 633 (1988) (recogniz-

ing the “congressional policy favoring private suits as an

important mode of enforcing federal securities statutes”);

Basic Inc. v. Levinson, 485 U.S. 224, 245 (1988) (noting that

presumption of reliance facilitates Rule 10b-5 litigation and

therefore supports the congressional policy embodied in the

20

1934. Act); Bateman Eichler, Hill Richards, Inc. v. Berner,

472 U.S. 299, 310 (1985) (denying application of in pari

delicto defense and observing that “private actions provide ‘a

mos: effective weapon in the enforcement’ of the securities

laws”) (citations omitted).

In some cases, the Court has recognized limits on the

application of these policies and has declined to adopt a broad

interpretation of the securities laws. Where for example, the

text of a statute simply does not permit a broad interpretation,

the Court has subordinated the policy of investor protection to

the text of the law as written. This was the principal rationale

for the Court’s unwillingness to recognize aiding and abetting

liability in Central Bank. See 511 U.S. at 173, 177 (holding

that “the text of the statute controls our decision” and adding

that the issue “is not whether imposing private civil liability

on aiders and abettors is good policy but whether aiding and

abetting is covered by the statute”). Similarly, where Con-

gress has deliberately tempered private rights of action

through amendments to the securities laws, as it did in the

Private Securities Litigation Reform Act of 1995 (“PSLRA”),

the Court has respected those limits as well. See Dura

Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 346 (2005)

(PSLRA makes clear Congress’s intent to permit recovery

in private action only where plaintiffs adequately allege

causation and loss).

> In Central Bank, the Court actually did consider policy implications.

It speculated that uncertainty surrounding the scope of aiding and abetting

liability might cause legitimate service providers in the securities industry

to fall victim to strike suits and to respond by either withholding their

services or passing increased costs on to clients and shareholders. See

511 U.S. at 189. These concerns are not relevant here because little un-

certainty surrounds the use of deception as the test for primary liability.

Moreover, shortly after Central Bank, Congress addressed the problem of

strike suits in the Private Securities Litigation Reform Act of 1995.

21

No such statutory limitations apply in this case, however.

The wording of Section 10(b) poses no obstacle to the theory

of liability advanced by the Petitioner in this case. To the

contrary, the broad phrasing of Section 10(b) easily ac-

commodates the Respondents’ deceptive acts. In PSLRA,

Congress instituted heightened pleading requirements, limits

on discovery, and other measures aimed at inhibiting abusive

strike suits, but it chose nof to restrict the nature of the

“manipulative or deceptive” devices constituting fraud under

Section 10(b), nor did it limit the category of “persons”

subject to its antifraud provision.® See 15 U.S.C. § 78u-4. In

short, neither the securities laws nor the decisions of this

Court can justify a narrow interpretation of Section 10(b) in

this case. The Court therefore should give full sway to the

dual goals of deterring securities fraud and allowing investors

to recover their losses.

C. Allowing the Petitioner’s Claims to Proceed

Will Further the Deterrent and Remedial Goals

of the Exchange Act

Applying Section 10(b) to the type of deceptive conduct at

issue in this case will serve these important policies. A hold-

ing that views the Respondents’ conduct as falling within the

scope of Section 10(b) will help deter similar violations by

others who are tempted to participate in fraudulent schemes.

We are in an era when companies feverishly strive to bolster

* In PSLRA, Congress felt compelled to address the problem of abu-

sive lawsuits, but it also recognized, and sought to preserve, the beneficial

role of private actions in combating securities fraud: “Private securities

litigation is an indispensable tool with which defrauded investors can

recover their losses without having to rely upon government action.” See

H.R. CONF. REP. NO. 104-369 (1995), 1995 WL 709276, at *31. More-

over, Congress recognized that “[sJuch private lawsuits promote public

and global confidence in our capital markets and help to deter wrongdoing

and to guarantee that corporate officers, auditors, directors, lawyers and

others proper!-: perform their jobs.” Jd. (emphasis added).

22

publicly announced revenues to sustain their share prices,

often by issuing fraudulent financial statements. Companies

have partnered not just with their accountants, but also with

their investment banks (as in Enron) and their outside vendors

(as in this case) in deceptive schemes designed to add credi-

bility and camouflage to those misleading reports. The Court

in Central Bank acknowledged that in complex securities

fraud cases, “there are likely to be multiple violators.” See

511 U.S. at 191. Allowing investors to seek recourse in such

cases will discourage the participation of such consultants and

outside business partners in fraudulent schemes.

Reversal of the lower court’s narrow interpretation of

Section 10(b) will also help investors recover their losses

arising from securities fraud. Often the companies directly

responsible for the dissemination of false financial statements

have collapsed under the weight of the fraud, leaving the

other participants in the scheme to answer for the losses that

investors have suffered. By exposing all parties responsible

for the fraud to civil liability, the law will afford at least some

chance of recovery to those who have lost their invest-

ments—often their life savings—as a result of the defendants’

culpable behavior.

D. Giving Investors Fair Access to the Courts Is

Vital Given the Rise in Fraud, the Statutory

Limitations that Congress Has Already Placed

on Private Actions, and the Lack of Alternative

Remedies Under State Law

The need to ensure that investors have meaningful private

remedies in federal court has become especially acute as a

result of the enactment of PSLRA in 1995. Since then, there

has been a marked rise in the incidence of corporate ac-

counting fraud and securities law violations affecting large

classes of investors. Congress recognized the seriousness of

the problem, and the need for at least a partial legislative

23

response, when it enacted the Sarbanes-Oxley Act of 2002,

15 U.S.C. §§ 7201-7266. The House Report accompanying

the House bill aptly describes the problem of deceptive

corporate practices that harm investors:

The collapse of the Enron Corporation provided irrefu-

table evidence of serious, systemic problems in our

financial reporting system and our capital markets. Far

from being an isolated instence, Enron was only the

most spectacular example of what has become a com-

mon phenomenon—earnings manipulation and deceptive

accounting by our largest companies. Before Enron,

company after company—-Waste Management, Sun-

beam, Cendant, W.R. Grace, and many others—were

found to have manipulated their accounting to present a

picture to investors that did not match reality. Az evi-

denced by the record number of investigations opened

by the SEC thus far this year [2002], the problem has

only become more acute.

See H.R. REP. No. 107-414 (2002), 2002 WL 661614, at *47

(Minority Views);’ see also, e.g., Press Release, No. 2002-

179, SEC, NY Attorney General, NASD, NASAA, NYSE

and State Regulators Announce Historic Agreement to

Reform Investment Practices (SEC, Dec. 20, 2002), available

at http://www.sec.gov/news/press/2002-179.htm; Press Re-

lease, State Investigation Reveals Mutual Fund Fraud (Office

of New York Attorney General, Sept. 3, 2003), available at

http://www.oag.state.ny.us/press/2003/sep/sep03a_03.html.

For the most part, the laudable provisions of Sarbanes-Oxley are

focused on enhancing the regulatory oversight of corporate accounting

practices and toughening the penalties for violations of the securities laws.

See, e.g., Title I, 15 U.S.C. §§ 7211-19 (establishing an accounting over-

sight board for public companies); Title VIII, Section 807, 18 U.S.C.

§ 1348 (increasing criminal penalties for defrauding shareholders of pub-

licly traded companies). It remains for the courts to interpret the securi-

ties laws in a manner that affords investors an adequate means of redress

for corporate malfeasance.

24

Those violations have harmed millions of investors nation-

wide, inflicting huge personal losses. Yet the number

of securities fraud class action lawsuits filed in the federal

courts has declined, and dismissal rates have increased since

PSLRA was enacted. See generally Hearing on H.R. 5491,

Before the House Committee on Financial Services, Sub-

committee on Capital Markets, Insurance, and Government

Sponsored Enterprises, 109th Cong. (2006) (Statement of

James D. Cox), available at http://www.law.duke.edu/

features/pdf/coxtestimony.pdf; Ronald I. Miller, Todd Foster,

and Elaine Buckberg, Recent Trends in Shareholder Class

Action Litigation: Beyond the Mega-Settlements, is Stabiliza-

tion Ahead? Apr. 2006, available at http://www.nera.com/

image/BRO_RecentTrends2006_ SEC979_ PPB-FINAL.pdf

(National Economic Research Associates, Inc.).

These conflicting trends have prompted experts in the secu-

rities field to surmise that because of PSLRA, “the balance

has been tipped too far in favor of preventing claims (some

of which would, after discovery, turn out to have merit)

rather than protecting investors who have suffered losses.

That is, Congress swung the pendulum too far in protecting

defendants.” Kevin S. Schmelzer, The Door Slammed Shut

Needs to be Reopened: Examining the Pleading Requirements

Under the Private Securities Litigation Reform Act, 78 Temp.

L. Rev. 405, 426 (2005); see also Joel Seligman, Rethinking

Private Securities Litigation, 73 U. Cin. L. Rev. 95, 113

(2004) (“the diminution in the effectiveness of private federal

securities litigation was one of the several facts that

contributed to a reduction in fraud deterrence.”). In short,

Congress has adopted legislative measures that are more than

adequate to protect industry from abusive lawsuits. Where

claims of fraud lie well within the statutory boundaries that

Congress has set, as they do here, there is no justification for

a narrow interpretation of the law that further limits the

ability of investors to seek relief.

25

Federal relief is all the more important when state law does

not provide an alternative remedy. This Court has observed

that the disadvantages posed by a restrictive interpretation of

federal securities law can be “attenuated” where adequate

remedies are available under state law. See Blue Chip Stamps

v. Manor Drug Stores, 421 U.S. 723, 738 n.9 (1975) (weigh-

ing fact that class action in state court was an alternative

remedy); see also Santa Fe Industries, Inc. v. Green, 430 U.S.

462, 478 (1977) (state cause of action under corporate law

was a factor in determining whether to recognize federal

cause of action); J.J. Case Co. v. Borak, 377 U.S. 426, 434-35

(1964) (noting that if federal jurisdiction is limited and state

affords no relief, then the “whole purpose” of the statutory

provision might be frustrated). Conversely, where state law

does not offer a significant alternative forum for plaintiffs’

claims, there is a correspondingly greater justification—and

need—for the federal courts to afford relief.

In this case, state law offers limited recourse for investors

in the Petitioner’s position. Congress has expressly limited

the use of class action suits seeking recovery for securi-

ties fraud under state law. In 1998, Congress enacted the

Securities Litigation Uniform Standards Act (“SLUSA”) to

address the concern that “securities class action lawsuits [had]

shifted from Federal to state courts” as a means of circum-

venting PSLRA. See Notes, 15 U.S.C.A. § 78a (excerpt from

Congressional findings in Pub. L. 105-353, § 2, Nov. 3,

1998). With certain exceptions, SLUSA provides that no

class action based upon state law may be maintained in any

State court on behalf of more than 50 class members. See 15

U.S.C. § 77p(b). Moreover, state courts generally have not

recognized the doctrine of fraud-on-the-market in cases

seeking relief under state common law, further limiting the

state courts as an alternative forum for investors aggrieved by

large-scale market manipulation of the sort alleged in this

case. See, e.g., Peil v. Speiser, 806 F.2d 1154, 1163 (3rd Cir.

1986) (no states have adopted fraud on the market theory);

26

Kaufman vy. i-Stat Corp., 754 A.2d 1188, 1193-94 (N.J.

2000); Mirkin v. Wasserman, 858 P.2d 568, 584 (Cal. 1993).

Precisely because of the massive corporate frauds that have

surfaced in recent years, some courts have recognized the

need to re-evaluate barriers to civil actions alleging securities

fraud. The California Supreme Court, for example, has cited

the troubling increase in corporate fraud as a reason to

recalibrate the balance between the interests of investors and

the interests of corporations, in favor of providing greater

judicial recourse to victims of fraud:

When Congress enacted the Private Securities Litigation

Reform Act of 1995 and the Uniform Standards Act of

1998, it was almost entirely concerned with preventing

nonmeritorious suits. (Stout, supra, 38 Ariz. L. Rev.

711). But events since 1998 have changed the per-

spective. The last few years have seen repeated reports

of false financial statements and accounting fraud, dem-

onstrating that many charges of corporate fraud were

neither speculative nor attempts to extort settlement

money, but were based on actual misconduct. “To open

the newspaper today is to receive a daily dose of

scandal, from Adelphia to Enron and beyond. Sadly,

each of us knows that these newly publicized instances

of accounting-related securities fraud are no longer

out of the ordinary, save perhaps in scale alone.”

(Schulman, et al., The Sarbanes-Oxley Act: The Impact

on Civil Litigation under the Federal Securities Laws

from the Plaintiff's Perspective (2002 ALI-ABA Cont.

Legal Ed.) p.1.) The victims of the reported frauds,

moreover, are often persons who were induced to hold

corporate stock by rosy but false financial reports, while

others who knew the true state of affairs exercised stock

options and sold at inflated prices. (See Purcell, The

Enron Bankruptcy and Employer Stock in Retirement

Plans, Congressional Research Service (Mar. 11, 2002).)

Eliminating barriers that deny redress to actual victims

27

of fraud now assumes an importance equal to that of

deterring nonmeritorious suits.

See Small v. Fritz Companies, Inc., 65 P. 3d 1255, 1263-64

(Cal. 2003).

As financial crimes abound and as alternative forums for

aggrieved investors remain limited, it is especially important

that the federal courts interpret federal law in a way that, to

the extent possible, affords meaningful remedies to victims of

securities fraud. Reversing the lower court’s decision will

help accomplish this objective.

CONCLUSION

For the reasons set forth above, the decision of the

United States Court of Appeals for the Eighth Circuit should

be reversed.

Respectfully submitted,

ALFRED E. T. RUSCH *

Senior Counsel

District of Columbia Securities Bureau

810 First Street, N.E.

Suite 701

Washington, D.C. 20002

(202) 442-7850

REX A. STAPLES

General Counsel of NASAA

STEPHEN W. HALL

Deputy General Counsel of NASAA

JOSEPH V. BRADY

Associate General Counsel of NASAA

LESLEY M. WALKER

Associate Counsel of NASAA

NORTH AMERICAN SECURITIES

* Counsel of Record ADMINISTRATORS ASSOCIATION, INC.

June 11, 2007