Amicus Curiae Brief — Stoneridge Inv. Partners v. Scientific-Atl.
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a
x — FILED
se DQ JUN 1 1 2007
No. 06-45 OFFICE OF THE CLERK
Ju the Supreme Court of the din SURREME GOURT U.S.
STONERIDGE INVESTMENT PARTNERS, LLC,
Petitioner.
v.
SCIENTIFIC-ATLANTA, INC., et al.,
Respondents.
ON WRIT OF CERTIORARI TO
THE UNITED STATES COURT OF APPEALS
FOR THE EIGHTH CIRCUIT
BRIEF OF OHIO, TEXAS AND 30 OTHER STATES
AND COMMONWEALTHS AS AMICI CURTAE
IN SUPPORT OF PETITIONER
GREG ABBOTT MARC DANN
Attorney General of Texas — Attorney General of Ohio
DAVID C. MATTAX ELISE W. PORTER*
) Division Chief Acting Solicitor General
, Financial Litigation *Counsel of Record
Division CHRISTOPHER R. GEIDNER
Office of the Attorney ROBERTI J. KRUMMEN
General Deputy Solicitors
P.O. Box 12548 BETH A. FINNERTY
Austin, TX 78711 RANDALL W. KNUTTI
512-463-0150 _ ANDREA L. SEIDT
5§12-477-2348 fax Assistant Attorneys General
30 E. Broad St., 17th Floor
Columbus, OH 43215
614-466-8980
614-466-5087 fax
Cancel far Aniics Statec
TALIS J. COLBERG
Attorney General
State of Alaska
TERRY GODDARD
Attorney General
State of Arizona
LINDA SINGER
Attorney General
District of Columbia
RICHARD BLUMENTHAL
Attorney General
State of Connecticut
MARK J. BENNETT
Attorney General
State of Hawaii
LISA MADIGAN
Attorney General
State of Illinois
THOMAS J. MILLER
Attorney General
State of lowa
GREGORY D. STUMBO
Attorney General
Commonwealth of Kentucky
G. STEVEN ROWE
Attorney General
State of Maine
DOUGLAS F. GANSLER
Attorney General
State of Maryland
MARTHA COAKLEY
Attorney General
Commonwealth of
Massachusetts
MICHAEL A. COX
Attorney General
State of Michigan
LORLSWANSON
Attorney General
State of Minnesota
Jim HOOD
Attorney General
State of Mississippi
MIKE MCGRATH
Attorney Genera!
State of Montana
JEREMIAH W. (JAY) NIXON
Attorney General
State of Missouri
CATHERINE CORTETZ MASTO
Attorney General
State of Nevada
KELLY AYOTTE
Attorney General
State of New Hampshire
GARY KING
Attorney General
State of New Mexico
ANDREW CUOMO
Attorney General
State of New York
WAYNE STENEHJEM
Attorney General
State of North Dakota
W.A. DREW EDMONDSON
Attorney General
State of Oklahoma
HARDY MYERS
Attorney General
State of Oregon
ROBERTO J. SANCHEZ-RAMOS
Attorney General
Commonwealth of Puerto Rico
HENRY MCMASTER
Attorncy General
State of South Carolina
ROBERT E. Cooper, JR.
Attorney General
State of Tennessee
MARK L. SHURTLEFF
Attorney General
State of Utah
WILLIAM H. SORRELL
Attorney General
State of Vermont
DARRELL V. MCGRAW, JR.
Attorney General
State of West Virginia
J.B. VAN HOLLEN
Attorney General
State of Wisconsin
QUESTION PRESENTED
Whether shareholders can recover damages from actors who,
acting with the requisite intent to deceive, actively engage in
conduct that has the principal purpose and effect of creating a
false appearance of fact in furtherance of a scheme to defraud
the securities market, even when the actor has made no false
statement or omission and otherwise owes no fiduciary duty
to the shareholders.
iv
TABLE OF CONTENTS
Page
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SUMMARY OF THE ARGUMENT..................:cscccsccccceees 4
RTE iiencii ctnscicataniniaventiiicdaeadaviiindienaiienivinnteninentatnsionetintints 6
A. Eliminating schenie liability for “non-
speaking” actors will improperly exempt
culpable banks, lawyers, accountants,
vendors, and other non-issuing entities
who all must be deterred for the
securities regulation system to function
STUEEIIIIIDN- sestitinieniiiecbienetibcbiniisiabinbianamiinaetinniintiehigninesis 6
Be SN iccrisisshinisncinianiidnabeiatinnsaiieniniicvtiies 6
B=, aI. bclaahiclindaiadaniciehaiadbbanidatanbiwede 8
ie ice ich eanenanertecumnlinbiiniyinbicestenmnicninées 10
B. Eliminating scheme liability for “non-
speaking” actors will significantly
diminish victims’ right to compensation
under the Securities LAWS. .............0.00.cesseesesseeee 12
C. Liability for “non-speaking” actors in a
securities fraud scheme should turn on
the principal purpose and effect of those
actors’ own conduct and — their
culpability, not whether those actors
personally made (or — successfully
v
avoided public attribution of) a false
SRE Gy CII, vo ccc viinittniudicnbiiadeamineen 15
1. The plain language of Section 10(b)
does not limit liability to actors
making public — statements = or
GUIIOID. cciscevsetsinevntonssisisinntaiiiamaamaias 15
2. The plain language of Rule 10b-5
does not limit liability to actors
making public — statements or
GUID, 00 vcnvscrcintnnitontieninsiisasiaanmaan 17
3. Central = Bank supports the
proposition that actors using or
employing a manipulative’ or
deceptive device may be liable as
primary violators of Section 10(b) or
BRU BURDAD, cocrncss0ss0ssss ssunsosniaipainaianaeel 20
4. “Non-spceaking™ actors are subject to
primary liability as long as their own
conduct contributing to the scheme
has a deceptive purpose and effect. .......... 21
a. Primary liability under Section
10(b) and Rule 10b-5 may attach
to “non-speaking” actors for false
Statements and omissions, even if
the actors did not personally
make the statement or omission. ........ 22
b. Primary liability may attach to
“non-speaking” actors for
participation in a scheme to
defraud if (1) the scheme had the
principal purpose and effect of
creating a false appearance of
fact and (2) the actors’ own
vi
conduct contributing to the
scheme had a deceptive purpose
a iesaetsin 25
EER ELC ee 28
Vil
TABLE OF AUTHORITIES
Cases Page(s)
A. T. Brod & Co. v. Perlow,
pe Enero nTIEneE 20
Adam v. Silicon Valley Bancshares,
884 F. Supp. 1398 (N.D. Cal. 1995)...000000 ee 23
Affiliated Ute Citizens of Utah v. United States,
Se SEIT TII stctisinicecieniinendiemenneienninnniinaneonieneatains 18,19
Anixter v. Home-Stake Prod. Co.,
eg F Lo | EER EEEESeesee 23
Blue Chip Stamps v. Manor Drug Stores,
A FR, SI eettecetanccscinnenicinnenminnemetvinmmnitita 15
Central Bank of Denver v. First Interstate Bank of Denver,
Oe le COE cprncncensceesennsennansienamenniteniatannnin passim
In re Charter Communications, Inc., 2004 U.S. Dist. Lexis
I I iinet icaecece eee cela 6
In re Charter Communications, Inc., 2004 U.S. Dist. Lexis
I celal 7
Chevron, U.S.A., Inc. v. NRDC, Inc.,
EERE ener ere eee Ere 25
Ernst & Ernst v. Hochfelder,
eG SRE TIT iasninseiiesinerneiicentisinicinanlideambanniees 15, 16
ix
In re Fannie Mae Sec. Litig.,
2007 U.S. Dist. Lexis 33939 (D.D.C. May 8, 2007)....... 4
Hill v. Hanover Energy, Inc.,
1991 U.S. Dist. Lexis 18566 (D.D.C. Dec. 16,
Howard v. Everex Sys., Inc.,
eS le Ce CRE Ges DD creer teen cctsessecerncteenenspnssesnies 22
McGann v. Ernst & Young,
102 F.3d 390 (9th Cir. 1996) cert. denied ...........0.....06.. 24
McNamara v. Bre-X Minerals Ltd.,
2001 U.S. Dist. Lexis 4571 (E.D. Tex. Mar. 30, 2001) 24
Newby v. Enron Corp.,
2006 U.S. Dist. Lexis 43146
I a eaecieninebenil 26
Public Empls. Ret. Svs. of Ohio v. lastow,
Case No. 02-CVH09-977, MDI -1446 (S.D.
I UN cilities 4
Regents of the Univ. of Cal. v. Credit Suisse First Boston
(USA), Inc., 482 F.3d 372 (Sth Cir. 2007).............. passim
Santa Fe Indus., Inc. v. Green,
ES Rr SRN RTE ne 16, 17
SEC v. Cupital Gains Research Bureau,
Eid tinkadhiiasctiiins aieseacenessndesipppiamiileadsinbiniiaande 19
SEC v. Zandford,
ETL CASE 16, 19, 25
Simpson v. AOL Time Warner, Inc.,
Ge Fi Oe Be Ce Cite Bcc cccccccncccscccsccceseccsese passim
In re Software Toolworks Inc. Sec. Litig.,
I. CI cietanticitacnencennnenimccnenimmenencios 22
Stoneridge Investment Partners, LLC v. Scientific-
Atlanta, Inc., 443 F.3d 987 (8th Cir. 2006)............ passim
Superintendent of Ins. v. Bankers Life & Cas. Co.,
Te ncecstashiusiuitidnicbinitibieniiinteitabiintinneniidenensionss 20
In re Union Carbide Corp. Consumer Prods. Bus. Sec.
Litig., 676 F. Supp. 458 (S.D.N.Y. 1987)... eee 23
United States v. O'Hagan,
fk, ESRC re ann ne eee re 19
Wenneman v. Brown,
49 F. Supp. 2d 1283 (D. Utah 1999) ooo .. 23
Wright v. Ernst & Young LLP,
FO Fe CU Ge ls BOT ccccsccvctscececesecevesesososensens 23, 24
Ziemba v. Cascade Int'l, Inc..
ee ae OE OG Pee Galle Be Peccctersscesccceccoscocncncsescnssben 24
In re ZZZZ Best Sec. Litig.
864 F. Supp. 960 (C.D. Cal. 1994)...............0c000-..cc000e. 23
Statutes
ST 2, 5,17
xi
FP icy SEIT crsriveestesniemncipncinaiiseniansiaiiniieeienteneionantinl 8
Be re Se Oe EE ccscennssiinirerrveisenieansvviomnnmeniniiiaiinn 8
Rules
Fr a I ticentierinninennitniintinnainniiguinscias passim
FF i as I i cciccerscsensesnessmvennipetdeiiedeniiiineiciats 18
0 Cr te GCN PID vencncevesessesorcoseassonnesnsenesncssoesenesoneee 18
i ale Es cnnceceennposensnencienntennitpunnsnntuiiidis 18,19
Briefs
Stoneridge Inv. Partners v. Scientific-Atlanta, Inc.,
Brief of Appellee Scientific-Atlanta, 2005 U.S.
8th Cir. Briefs Lexis 212 (Aug. 15, 2005)..................... 2
Stoneridge Inv. Partners v. Scientific-Atlanta, Inc.,
Brief of Appellee Motorola, Inc., 2005 U.S. 8th
Cir. Briefs Lexis 70 (Aug. 15, 2005)..............0....0......44. 2
Stoneridge Inv. Partners v. Scientific-Atlanta, Inc.,
Brief of Appellant-Petitioner, 2005 U.S. 8th Cir.
Briefs Lexis 247 (Jume 14, ZOOS) ........ccccccccosrcccscccscoesees 2
Other Authorities
Damien Cave, 40/ Reasons to Love Enron,
I I I a lait aee 13
XII
Charter Communications Holdings LLC Form 10-K
for year ended December 31, 2000 (filed with
Securities and Exchange Commission on April
ile. SITET Picieisncussigennsosevennesenanseseneinnsenseotrnceseusecsonsseoeoenes
Christopher Cox, Chairman, Sec. Exch. Comm'n,
Remarks to the U.S. Chamber of Commerce’s
First Annual Capital Markets Summit: Securing
America’s Competitiveness (Mar. 14, 2007) ..........
Press Release, University of California, Banks, law
firms, were pivotal in executing Enron securities
fraud, www.ucop.cdu/news/enron/art408 htm
IE Siu, Ge cscenennsenenisnsccensngneninmnenbeiaisnnssteueseneeevens
Press Release, University of California, UC and
Enron Investors Join Coalition Urging the SEC
to Protect Investors and Hold Banks
Accountable kor Securities Fraud,
www.universityofcalifornia.edu
/news/2007/may09. html (May 9, 2007)..................
John Gibeaut, An Outside Shot at Securities Fraud,
A.B.A. J. EEE SO ne ee Ne
Homestore.com, Inc. Class Action Settlement
Information Website, “Q&A,”
http://www.homestoresettlement.com/questions.
shtml (last visited May 30, 2007). ..............000cceeee
Keith L. Johnson, Deterrence of Corporate Fraud
Through Securities Efagation: The Role of
Institutional Investors,
60 Law & Contemp. Probs. 155 (Autumn 1997)....
wn"
—
Xl
Christopher Ketcham, Enron's Human Toll,
KR 8 Ea oe See mee
Harold Meyerson, Enron's Enablers: The Finance
Firms That ‘Drove the Getaway Car’,
Washington Post, May 9, 2007, at Al7...................
John C. Roper, 4 Ex-Merill Lunch Execs’
Convictions Overturned,
Houston Chronicle, Aug. 2, 2006, at A} ..................
Christopher S. Rugaber, Court to consider ‘scheme
liability’ in Stoneridge suit against Motorola,
Scientific-Atlanta,
The Associated Press (Mar. 26, 2007) .....................
Press Release, U.S. Dep’t of Justice, Ex-CEO of
Homestore.com Sentenced to 15 Years in
Federal Prison for Orchestrating Scheme That
Ilegallv Inflated Company's Revenue (Oct. 12,
2006),
www.losangeles.fbi.gov/dojpressrel/pressrel | 10
a al
Webster's International Dictionary (2d ed. 1934)..........
Chery! Wittenauer, Charter Communications
Executives Sentenced In Accounting Schemes,
The Detroit News, Apr. 23, 2005
www.detnews.cony/2005/business/0504/2 3/biz-
a iniciunscitnotnsiininnidiienimaninninentnsninvantioninsunnenees
INTRODUCTION
This case has been described as “probably the most
important legal issue for the securities industry in a
generation.” The Court’s decision here will profoundly
affect not only the market as a whole, but investors large and
small, and the faith that those investors will have in the
market for years to come. The amici States urge the Court to
support a healthy securities market, and the investors who
rely on it, by overruling the Eighth Circuit below.
Our nation’s system of monitoring fraud and eliminating
it from the securities market relies on two fundamental
presumptions: (1) wrongdoers disrupting the markct should
be held accountable for their bad acts and (2) those wronged
should be compensated for their losses.’ Violators of the
securities laws therefore face the prospect of both criminal
and civil liability for their conduct, with cases being
prosecuted by state and federal securities regulators as well
as by individual and class plaintiffs acting as “private
attorneys gencral.” Over time, this system has promoted
market integrity, bolstered investor confidence, and made
American markets what they are today: the global leaders
“set[ting] the standard for the rest of the world.’ This case
poses the question whether the law will continue to protect
the markets by providing a remedy for the wrongs suffered as
the result of fraudulent corporate schemes under Section
10(b) of the Securities Exchange Act of 1934, 15 U.S.C.
l - 2 ‘ . . . i . .
Chnstopher S. Rugaber, Court to consider ‘scheme liability’ in
Stoneridge suit against Motorola, Scientific-Atlanta, Associated Press
(Mar. 26, 2007) (quoting Robert Giuffra, attorney at law firm Sullivan &
Cromwell).
* Keith L. Johnson. Deterrence of Corporate Fraud Through Securities
Litigation: The Role of Institutional Investors, 60 Law & Contemp.
Probs. 155 (Autumn 1997).
* Christopher Cox, Chairman, Sec. Exch. Comm'n, Remarks to the U.S.
Chamber of Commerce's First Annual Capital Markets Summit: Securing
America’s Competitiveness (Mar. 14, 2007).
2
§78(j)(b), and SEC Rule 10b-5, 17 C.F.R. §240.10b-5.
Investors (and other interested parties) here and abroad are
anxiously awaiting the answer.
Petitioner Stoneridge Investment Partners, LLC
(“Stoneridge”) and Respondents Scientific-Atlanta, Inc.
(“Scientific-Atlanta”) and Motorola, Inc. (“Motorola”) offer
the Court two competing answers to the question. Stoneridge
has argued that wrongdoers should be held liable for
damages as primary violators under Rule |10b-S(a) and (c)
where they participate in a “scheme or artifice to defraud” or
by “engaging in a ‘course of business which operates . . . as a
fraud or deceit.’” Stoneridge Investment Partners, LLC v.
Scientific-Atlanta, Inc. (In re Charter Commce'n, lic. Sec.
Litig.) (“Stoneridge”), 443 F.3d 987, 991 (8th Cir. 2006). In
Stoneridge’s view, the defendant need not make misleading
statements Or Omissions to be held liable; participating in a
sham transaction with no legitimate business or cconomic
purpose and with the requisite scienter should suffice.
Stoneridge, Brief of Appellant Stoneridge, 2005 U.S. 8th Cir.
Briefs Lexis 1974, at *22-31 (June 14, 2005).
On the other hand, Scientific-Atlanta and Motorola have
argued that a defendant must makc a misleading statement or
omission to be held liable under Section 10(b) or Rule 10b-5
and, thus, scheme defendants who remain silent and owe no
duty of candor to investors. are categorically exempt.
Stoneridge, Brief of Appellee Scientific-Atlanta, 2005 U.S.
8th Cir. Briefs Lexis 1974, at *10-13 (Aug. 15, 2005):
Stoneridge. Brief of Appellee Motorola, Inc., 2005 U.S. 8th
Cir. Briefs Lexis 1974, at *19-24 (Aug. 15, 2005).
The circuit courts considering the issue are split. The
Ninth Circuit, in the Homestore case, articulated a test in line
with Stoneridge’s position, whereby participants in schemes
with the “principal purpose and effect” of defrauding
investors are held liable whether or not they made misleading
statements or omissions to investors. Simpson v. AOL Time
Warner, Inc. (In re Homestore.com, Inc. Sec. Litig.)
(“Homestore’’), 452 F.3d 1040, 1048 (9th Cir. 2006). By
contrast, the Eighth Circuit in Stoneridge and the Fifth
Circuit in Enron have adopted Scientific-Atlanta and
Motorola’s narrow interpretation of scheme liability based on
an erroneous interpretation of this Court’s decision in
Central Bank of Denver v. First Interstate Bank of Denver,
S511 U.S. 164 (1994). See Stoneridge, 443 F.3d at 992:
Regents of the Univ. of Cal. v. Credit Suisse lirst Boston
(USA), Inc. (“Enron”), 482 F.3d 372, 387 (Sth Cir. 2007).
Amici States urge the Court to adopt our approach, which
follows the Ninth Circuit’s Homestore holding and, in this
case, Stoneridge’s position. This is the proper standard
because the plain language of Section 10(b) and Rule 10b-5
reflects Congress’s purpose that no defendant should be
immune from scheme liability when that defendant possesses
the requisite intent to deceive and actually engages in
conduct that does in fact deceive investors. Indeed, our
system of monitoring and eliminating securities fraud would
be severely undermined if, as the Fifth Circuit recently ruled,
the parties who “could have pulled the plug on Enron” get to
walk away. Enron, 482 F.3d at 392. Neither the spirit nor the
letter of the securities laws allows culpable individuals or
companies actively participating in fraud schemes to escape
liability for their actions. The amici States urge the Court to
grant Stoneridge relief by reversing the Eighth Circuit’s
decision below.
INTEREST OF AMICI STATES
Amici States have an interest in the outcome of this
appeal for several reasons. First, the States themselves are
investors, representing some of the largest institutional
investors in the world. In almost every case involving the
scheme liability issue presented here. a state pension fund is
4
either lead plaintiff, opt-out plaintiff, or a class member with
significant losses.*
Second, the amici States are uniquely sensitive to the
plight of their small, individual investors. While the PSLRA
has shifted the focus and responsibility for private securities
fraud class actions to large institutional investors like state
pension funds, it is often the small, individual investor who
loses the most. For when the Enrons of the world go
bankrupt, it is the States who come to these investors’ aid as
they face the day-to-day consequences of losing their jobs,
homes, and life savings as a direct result of securities fraud.
Finally, amici States have a direct interest in the integrity
and competitiveness of the securities markets from a public-
protection standpoint. Fraudulent actors of all types must be
deterred for the markets to function properly. The Court
should reverse the decision of the Eighth Circuit to maintain
this deterrence.
SUMMARY OF THE ARGUMENT
Amici States make three principal points. First, amici
States demonstrate that culpable parties will be improperly
shielded from liability if the Eighth Circuit is affirmed. This
group includes the unprincipled accountants, lawyers, and
banks, as well as unscrupulous vendors, who, even if they did
not make misleading statements or omissions themselves,
nonetheless intended to deceive and engage in sham
* For example, in Ohio, two large state pension finds recenily lost a
motion to dismiss a defendant bank based primarily on the Eighth and
Fifth Circuit scheme liability rulings at issue here. In re Fannie Mae Sec.
Litig., No. 04-1639, 2007 U.S. Dist. Lexis 33939, at *18-25 (D.D.C. May
8, 2007). Those same funds, plus two other Ohio funds, are also awaiting
a ruling against defendant bunks Merril Lynch. Credit Suisse First
Boston, and Barclays in a securities opt-out action, pending the related
appeal to this Coun of the Filth Circuit's opinion in Enron. See Pub.
Empls. Ret. Svs. of Ohio v. Fastow (in re Enron Corp. Sec. Litig.), Case
No. 02-CVH09-977, MDL-1446 (S.D. Tex. Mar. 20, 2007).
5
transactions. In the Enron frauds alone these “non-speaking”
defendants made billions of dollars in ill-gained profits.
Amici States oppose a rule that would allow defendants to
escape liability and retain these profits. Significantly, the
Court in Central Bank has already foreshadowed that these
types of parties should be held liable under appropriate
circumstances.
Second, amici States point out the other side of securitics
fraud cases: the victims. Amici States pay dearly in their own
right as holders of large institutional pension funds in
securities fraud schemes. But the most tragic cases are the
individual investors who lose everything they own. These
small investors need to recover at least some of the money
they lose as a result of fraudulent schemes. All fraudulent
actors, including those remaining silent, should contribute to
these victims’ recoveries.
Third, the amici States contend that “non-speaking”
actors should be held liable for a primary violation of Section
10(b) where those actors, intending to de ceive, actively
participate in a “scheme to defraud” in which the principal
purpose and effect of the scheme is to create a false
appearance or statement of fact in furtherance of the scheme.
It is not necessary for such actors to personally make the
false statement or omission. This is the standard adopted by
the Ninth Circuit in Homestore, and it is the standard that
best accomplishes the dual purposes of the sccuritics laws—
to punish wrongdoers and compensate victims. Amici States
accordingly urge the Court to overrule the conflicting Eighth
and Fifth Circuit decisions.
6
ARGUMENT
A. Eliminating scheme liability for “non-speaking”
actors will improperly exempt culpable banks,
lawyers, accountants, vendors, and other non-issuing
entities who all must be deterred for the securities
regulation system to function properly.
The plain language of the securities laws— § 10(b) and
Rule !0b-5—expressly prohibits all deceptive devices and
manipulative schemes involving the sales of securities. That
is precisely the guarantee and protection that amici States
advocate here. The Court need look no further than the facts
of Stoneridge, Homestore, and, of course, Enron to see the
reasons these protections should be maintained.
1. Stoneridge
In Stoneridge, two major cable equipment vendors
(Scientific-Atlanta and Motorola) “accepted and returned”
$20 payments from cable communications company Charter
Communications, Inc., in exchange for free advertising to
Charter’s more than 6.4 million cable customers in 40 states.”
See Stoneridge, 443 F.3d 987, 990 (8th Cir. 2006); In re
Charter Communications, Inc., 2004 U.S. Dist. Lexis 29647,
at *15 (E.D. Mo. 2004). As these figures suggest, Charter
was one of the largest cable-communications companies in
the country and a lucrative source of business for both
Scientific-Atlanta and Motorola.
According to the Stoneridge complaint, Scientific-Atianta
and Motorola worked directly with Charter in crafting the
sham transactions and knew that Charter was using the
“payments” to dupe investors into believing Charter was
* See Charter Communications Holdings, LLC, Form 10-K for year ended
December 31, 2000, at 4 (filed with Securities and Exchange Commission
on April 2, 2001).
meeting the operating-cash-flow expectations of Wall Street
analysts. In its opinion, the District Court for the Eastern
District of Missouri noted several allegations indicating that
“high level personnel” of both Scientific-Atlanta and
Motorola were in fact “direct participants in the scheme”:
e In August 2000, to cover a year-end operating-cash-flow
shortfall of $15-S$20 million, Charter’s CEO and COO
instructed John Pietri, Charter’s Senior Vice-President of
Engineering, to lobby Scientific-Atlanta and Motorola
(the “vendors”) to purchase time-slot advertising. The
vendors had no interest.
e Pietri’s superiors instructed him to approach the vendors
again, this time with sham business transactions that
would generate the appearance of operating-cash-flow
growth for Charter. Charter offered to pay the vendors an
additional $20 per set top box, provided the vendors
would “return” the $20 payment to Charter. Charter
would, in turn, give them free advertising. The vendors
agreed. As a result, Charter’s operating cash flow was
inflated by $17 million and the vendors received their
respective shares of $17 million worth of free cable
advertising.
e Executives from both vendors worked directly with Pietri
to fabricate documentation giving the transactions the
appearance of valid arms-length business transactions.
In re Charter Communications, Inc., 2004 U.S. Dist. Lexis
29679, at *10-17 (E.D. Mo. 2004).
Assuming the allegations above are truc, both Scicntific-
Atlanta and Motorola were active and knowing participants
in the scheme to defraud and should be held equally liable for
the harm the scheme caused Charter and its investors. In fact,
the particularities of Charter’s accounting scheme were
sufficiently cgregious to vield felony guilty pleas, probation
8
and prison time, and hefty fines for four of Charter’s former
executives.” Moreover, on the civil side, ten of Charter’s key
executives and Charter’s independent auditor Arthur
Anderson, LLP, paid a collective $144 million in cash and
stock to settle class-action claims against them.’ Scientific-
Atlanta and Motorola, however, who both received millions
in free advertising and millions more in equipment sales
contracts, have incurred no criminal or civil penalties for
their roles in the scheme. Stoneridge, 443 F.3d at 990.
The end result in Stoneridge, absent intervention by the
Court, ts that Scientific-Atlanta and Motorola retain their
millions in ill-gotten gains, while Charter investors are
unable to recover their millions in outstanding losses.
Moreover, Scientific-Atlanta and Motorola can earn millions
more in the next sham business transaction without penalty.
Other cable equipment vendors also will be enticed to engage
in these bogus but profitable transactions. Congress did not
intend this result in passing the Securities Exchange Act of
1934, PSLRA, 15 U.S.C. §78u-4 ef seg., which expressly
provides for proportionate and limited joint and several
liability; or SLUSA, 15 U.S.C. §78bb(a).
2. Homestore
In Homestore. an Internet company engaged in more
complicated “barter” or “round-trip” schemes with multiple
companies to overstate its revenues by more than $170
million. /lomestore, 452 F.3d at 1042. The other companics
allegedly participating in the scheme were AOL Time
Warner, Cendant Corporation, and L90.
® Cheryl Wittenauer, Charter Communications Executives Sentenced in
Accounting Schemes, The Detwoit News, Apr. 23, 2005
www detnews.com/200S, business’/0S04/23, biz- 159359 him, John
Gibeaut. 4n Outside Shot at Securines Fraud, A.B.A. J. June 2007.
,
ded.
9
According to the complaint, AOL was the first company
to take fraudulent advertising commissions from Homestore.
Homestore agreed to purchase shares in a thinly capitalized
third party at an inflated price in exchange for that
company’s agreement to pass virtually all of that money to
AOL in the form of “advertising fees.” AOL, in turn, would
share the advertising “revenue” with Homestore. The result
was a fraudulent “triangular transaction” in which Homestore
funneled money through the third party and AOL and back to
itself as needed to meet analysts’ revenue expectations.
Homestore’s alleged scheme with Cendant was much
simpler, though no less profitable. Homestore “grossly
overpa[id]” Cendant $750 million for the purchase of the
Web site Move.com, contingent on Cendant’s promise to
funnel some of the money back to Homestore. As with the
money funneled through AOL, Homestore recorded the
Cendant payment as “revenue” to meet analyst expectations.
Cendant set up a separate corporate entity, Real Estate
Technology Trust, which paid $95 million to Homestore for
products and services following the Move.com sale. It is not
clear how much of the remaining $655 million Cendant
retained from the “sale” as its “commission.”
L90’s participation was similar to AOL’s: funneling
funds through a third party. Homestore’s auditor became
suspicious and required a confirmation letter from L90 before
it would certify Homestore’s 10-Q securitics filing. L90 had
already earned millions in fraudulent commissions before
Homestore restated its financials.
As was the case with Charter, criminal and civil charges
were quickly filed against Homestore and its executives.
Eleven Homestore employees, including its former COO,
CFO, and VP of Finance, were convicted of federal offenses
in relation to the scheme. Homestore’s CEO was convicted of
conspiracy, tnsider trading, and falsifying corporate records
10
and SEC reports and received a |5-year prison sentence and
$5 million fine for his part.* On the civil side, Homestore and
several of its officers paid approximately $19 million in cash
plus 20 million shares of stock in settlement while
Homestore’s auditor, Price WaterhouseCooper, doled out an
additional $17.5 million to Homestore investors.” AOL,
Cendant, and L90, on the other hand, have not yet been held
liable for their conduct. Following the Ninth Circuit's
holding in Homestore—and unlike the “non-speaking” actors
in Stoneridge—these entities can be held hable and
compelled to pay their fair share, regardless of whether they
personally made a false statement or omission.'”
3. Enron
The well-known Enron case cqually illustrates the
reasons why the Fighth Circuit should be reversed.
Numerous players were involved in the schemes that
ultimately brought down the Houston corporate giant, among
them nine of the largest banks and brokerage firms on Wall
Street: J.P. Morgan Chase, Citigroup, Canadian Imperial
Bank of Commerce (“CIBC”), Bank of Amcrica, Deutsche
Bank, Lehman Brothers, Credit Suisse First Boston (“Credit
* Press Release, U.S. Dep't of Justice, Ex-CEO of Homestore.com
Sentenced to 15 Years in Federal Prison for Orchestrating Scheme That
legally Inflated Company's Revenue (Oct. 12, 2006), http:/Aosangeles
.fbi.zov/dojpressrel/pressrel06/a 101 206usa.htm.
” Homestore.com, Inc. Class Action Settlement Information Website,
“Q&A.” http://www. homestoresettIement.cony/questions.shtml —_ (last
visited June 11, 2007).
'’ To this point, the litigation in Homestore has not yet established
whether AOL, Cendant, and L90’s conduct, as a factual matter,
constituted active participation in a deceptive scheme whose principal
purpose and effect was to create a false statement of fact in furtherance of
the scheme as the H/omestore decision requires. 452 F.3d at 1054-55.
Suisse”’), Merrill Lynch & Company, Inc. (“Merrill Lynch”),
and Barclays Bank PLC (“Barclays”).'' Together, the banks
and brokerages raised $6 billion for Enron through fraudulent
debt and stock issues from 1996 through 2001 flus an
additional $4 billion they channeled into Enron’s sham
partnerships Jedi, Chewco, LJMI and LJM2.'’ The banks
and brokerages themselves earned hundreds of millions
individually—billions collectively—in commissions,
consulting, fees, and inflated interest. Moreover, select senior
managers from the banks personally pocketed milli»ns by
investing their own money in Enron’s “special entities” that
promised returns of 1,000 percent or more.'*
One of the Enron schemes relevant to this appea: is the
“Nigerian Barges Transaction.” According to the Enron
complaint, Enron “sold” its interest in clectricity-genzrating
barges off the coast of Nigeria to Merrill Lynch with a side
agreement to “buy back” that interest from Merrill Lynch six
months later at a 20% premium. As was the case in
Stoneridge and Homestore, the Enron plaintiffs allege that
Merl Lynch knew that Enron was using the sham
transaction to inflate its revenues in its year-end financial
statements.'* 482 F.3d at 392. The Fifth Circuit held that
'' Press Release, University of California, Banks, law firms, were pivotal
in executing Enron securities fraud,
hitp://www.ucop.edu/news/enron/an408.htm (Apr. 8, 2002)
? Ted.
id.
'* There is evidence to support that allegation, which the Fifth Circuit
specifically noted in its opinion. 482 F.3d at 377 n.1 (quoting: e-mail
between Merrill Lynch employees regarding the effect the ligerian
Barge transactions had on Enron’s stock price and Enron exc cutives’
personal compensation). However, Plaintiffs will not get the opportunity
to obtain additional evidence regarding Mernll Lynch's knowledge or
alleged involvement in the scheme unless the Fifth Circuit is reversed.
12
Merril! Lynch owed no duty to Enron investors and is free of
liability. /d.'°
!
Although the Fifth Circuit lamented that Merrill Lynch
and the other banks “do, after all, escape liability for alleged
conduct that was hardly praiseworthy,” the ultimate message
the Fifth Circuit opinion sends to the banks who did not settle
(and tc Enron investors) is that there is no legal recourse for
wrongs committed by “non-speaking” actors. /d. ”
In sum, unless the court below is reversed, unscrupulous
actors will keep the billions in ill-gotten gains and will
continue to engage in profitable but illicit transactions. That
is neither what Congress intended in the securities fraud laws
nor wiat this Court intended in deciding Central Bank.
Amici States urge the Court to reverse the Eighth Circuit’s
decisicn below.
B. Eliminating scheme liability for “non-speaking”
actors will significantly diminish victims’ right to
compensation under the securities laws.
En‘on’s employees and retirees are probably the best-
known victims of fraudulent securities practices. When the
company collapsed, more than 4,000 Houston employees lost
their jobs, and approximately 20,000 employees and retirees
15
On the criminal side, the Fifth Circuit also overturned the convictions
of four former Merrill Lynch executives actively engaged in the Nigerian
Barges Transaction. John C. Roper, ¢ Ex-Merrill Lynch Execs’
Convictions Overturned, Houston Chron., Aug. 2, 2006, at Al.
'° Credit Suisse had allegedly engaged in a similar sham transaction,
known 2s “Osprey.” 482 F.3d at 377 n.! (quoting email between Credit
Suisse e nployees acknowledging “Osprev is a vehicle enabling Enron to
raise disguised debt which appears as equity on Enron's balance sheet. .
.” (emphasis added)).
13
lost $1.3 billion in their 401(k) accounts.'’ What is worse, the
“employees most at risk were those who had expressed the
most faith in Enron by putting their own contributions into
Enron stock.” Like most employees of large public
companies, Enron employees had “the vast majority of their
assets in Enron stock.” *
Janice Farmer was one of those employees. “I! was proud
to invest in Enron stock,” she said in testimony before a U.S.
Senate committee. ““We were a loyal and hardworking group
of employees. We lived, ate, slept and breathed Enron
because we were owners of the company. | trusted the
management of Enron with my life savings.”'” Ms. 7armer
lost $700,000. Charles Prestwood was another Enron
employee. He saw his retirement nest egg dissolve almost
instantaneously. from $1.3 million to $8,000:
All Charles Prestwood wanted was to travel beyond
Texas. All he wanted was an employer thit
wouldn’t destroy his 401(k), a financia! system to
keep his employer honest, and, now, judges to hold
that employer and those banks liable for the theft of
his old age. “I cannot understand judges who would
look at the people who designed the theft, provided
the money to do it and drove the getaway car, and
say that they didn’t do anything. This country boy.”
'’ Damien Cave, 40/ Reasons to Love Enron, Salon, Jan. 1"', 2002,
http://air.salon.cony/story/tech/feature/2002/01/17/401Vindex.htm
'* 44 Enron employees had invested 60% of their assets in Company
stock, which is not unusual. Procter & Gamble employees invest 94% of
their assets in company stock, Sherwin-Williams employees inv zst 90%
of their assets in company stock, and Coca-Cola employees invest 81% of
their assets in company stock. /d/.
™ Quoted in Christopher Ketcham, Enron's Human Toll, Salon, Jan. 23,
2002, http://air.salon.convstory/techy feature/2002/01/23/enron to | /index
html.
14
he says, “has a hard time interpreting these
thiags.”~°
The only way for victims such as Ms. Farmer and Mr.
Prestwood to recover anything at all in_ catastrophic
bankri pting frauds like Enron is for culpable “non-speaking”
actors to be held liable. Virtually all of the record $7.1 billion
settlenient to investors in Enron came from “non-speaking”
actors: CIBC, $2.4 billion; JP MorganChase, $2.2 billion:
Citigroup, $2 billion; Lehman Brothers, $222.5 million; and
Bank of America, $69 million.”' Without those funds, many
indivicual Enron shareholders would have received nothing:
and without “scheme liability,” many more defrauded
investors will receive nothing. The amici States therefore
urge the Court to reverse the Eighth Circuit and allow
investors to recover from all culpable actors who actively
cngage in securities fraud schemes, regardless of whether
they personally made a material misstatement or omission.
”
Harold Meyerson, Enron's Enablers: The Finance Firms That ‘Drove
the Getaway Car’, Wash. Post, May 9, 2007, at Ai7.
Press Release. University of California, UC and Enron Investors Join
Coalition Urging the SEC to Protect Investors and Hold Banks
Account thle For Securines Fraud, http://www universityotcaliforma.edu/
news/2097/may09 html (May 9, 2007).
15
C. Liability for “non-speaking” actors in a securities
fraud scheme should turn on the principal purpose
and effect of those actors’ own conduct ant their
culpability, not whether those actors personally made
(or successfully avoided public attribution of) a false
statement or omission.
1. The plain language of § 10(b) does not limit
liability to actors making public statements or
omissions.
The federal securities laws, on their face, hold any person
liable for any manipulative or deceptive device or
contrivance. The language dees not make distinctions based
on title, profession, or industry; does not immunie any
category of persons or entitics; and. importantly, does not
limit liability to actors making public statements or
omissions. The language of the principal anti-fraud provision
of the federal securities laws is extremely broad. Section
1Q(b) of the Securities Exchange Act of 1934 makes it
unlawful, “directly or indirectly” for “any person. . . [t]o use
or employ, in connection with the purchase or sale of any
security . . . any manipulative or deceptive device or .. .
contrivance in contravention of such rules and regulations as
the [Securitics and Exchange] Commission may prescribe.”
Securities Exchange Act of 1934 § 10(b), 15 US.C.
§ 78(j)(b).~°
In addition, the Court has held that §10(b) broadly
prohibits the use of any “manipulative or deceptive device or
contrivance” in connection with the purchase or sale of
securities, including manipulation or deception as part of a
= In delinminy hability for securities fraud under § 1O¢b), the Court must
“turn first to the language of $ 10(b), for “the starting point in every case
involving construction of a statute is the language itself.” Erase & Erase
v. Hochfelder, 425 U.S. 185. 197 (1976) (quoting Blue Chip Siamps v-
Manor Drug Stores, 421 U.S. 723. 756 (1975)).
16
larger scheme to defraud the broader securities market. See
Ernst & Ernst v. Hochfelder, 425 U.S. 185, at 199 (1976). In
fact, in the context of a fiduciary relationship, the Court has
already held that that a non-speaking actor who engages in a
schem? to defraud has used or employed a deceptive device
within the meaning of § 10(b). SEC v. Zandford, 535 U.S.
813, 821-22 (2002). Moreover, the Court has recognized that
deception can be undertaken in a variety of ways other than
through false statements or omissions. In Ernst & Ernst, the
State Court stated that “device” broadly means “an invention:
project; scheme; often, a scheme to deceive; a stratagem: an
artifice,” and that “contrivance” means any “thing contrived
or used in contriving; a scheme, plan, or artifice.” 425 U.S. at
199 n.20 (quoting Webster’s International Dictionary (2nd
ed. 19:54)).
However, in its decision below, the Eighth Circuit
catego ically and improperly held 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 «luty to disclose.” Stoneridge, 443 F.3d at 992 (citing
Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 474-75 (1977)).
The Fighth Circuit’s interpretation of § 10(b) is not
supported by the statute’s text. Neither § 10(b) nor related
provisions make any reference to public statements or
omissions, but instead broadly prohibit the use of any
“manipulative or deceptive device or contrivance” connected
to the securities market.
In determining that deceptive conduct must involve
“either a misstatement or a failure to disclose by one who has
a duty to disclose.” the Eighth Circuit improperly relied on
this Court’s decision in Santa Fe. The Santa Fe Court
decided issues related to breach of fiduciary duty under Rule
10b-5-—not broader scheme liability under § 10(b). The
primary holding of the Santa Fe decision was that “breach of
fiduciary duty by majority stockholders. without any
17
deception, misrepresentation, or nondisclosure, [dees not
violate} the statute and the Rule.” 430 U.S. at 475-76. Indeed
the Sania Fe Court’s separate references to deception,
misrepresentation, and nondisclosure indicate that deceptive
conduct may take forms other than statements or omissions:
“Congress [in enacting § 10(b)] meant to prohibit the full
range of ingenious devices that might be used to mar ipulate
securities prices.” /d. at 477. The Eighth Circuit’s d2cision
below cannot be squared with either the statute’s text or this
Court’s clear statements regarding the breadth of § 10(b), and
must be reversed.
Given the plain language of § 10(b) and the definitions
sct forth by the Court, and regardless of statements or
omissions by the parties, amici States urge that conduct that
has the core purpose and effect of creating a falsc imp<cssion
in the securities realm can constitute a “manipula ive or
deceptive device or contrivance” under § I10(b). As
articulated by the Ninth Circuit in Homestore, 452 }.3d at
1052, the plain language of § 10(b) necessitates “that conduct
by a defendant that had the principal purpose and etfect of
creating a false appearance in deceptive transactions as part
of a scheme to defraud is conduct that uses or employs a
deceptive device within the meaning of § 10(b).”
2. The plain language of Rule 10b-5 does not limit
liability to actors making public statemeits or
omissions.
Section 10(b) expressly authorizes to the Securities and
Exchange Commission to define “manipulative or deceptive
devices or contrivances” through “such rules and regulations
as the Commission may prescribe as necessary or appr priate
in the public interest or for the protection of investo's.”” 15
U.S.C. §78G)(b). The SEC first exercised this authcrity in
1942 by adenting Rule |0b-5 to specify three overlapping yet
18
distinct categories of manipulative or deceptive devices or
contrivances:
(a) To employ any device, scheme, or artifice to
defraud,
(b) To make any untrue statement of a materia! fact
or to omit to state a material fact necessary in
order to make the statements made, in the light
of the circumstances under which they were
made, not misleading, or
(c) To engage in any act, practice, or course of
business which operates or would operate as a
fraud or deceit upon any person.
17 C.F.R. §240.10b-5. Only subsection 10b-5(b) provides
that the defendant make a deceptive misstatement or
omission. In contrast, subsections !0b-5(a) and (c) curtail
conduct and behavior, rather than statements. “To be sure,
the second subparagraph of the rule specifies the making of
an untrue statement of a material fact and the omission to
state a material fact. The first and third subparagraphs are not
so restricted.” Affiliated Ute Citizens of Utah v. United
States, 406 U.S. 128, 152-53 (1972).
Thus, under the plain language of Rule |0b-5S. a person or
other entity may be held liable for any of the following:
|. Employing a device to defraud;”*
2. Employing a scheme to defraud:**
Employing an artifice to defraud:**
oe
Making any untrue statement of a material fact:**
>
** 17 CER. $240.10b-5(a).
17 CER. $240.10b-5(b).
19
5. Omitting to state a material fact necessary in crder to
make the statements made, in the light of the
circumstances under which they were mace, not
misleading;~*
6. Engaging in an act which operates or would operate
as a fraud or deceit upon anyone:*
7. Engaging in a practice which operates or would
operate as a fraud or deceit upon anyone; or
8. ‘Engaging in a course of business which operates or
would operate as a fraud or deceit upon anyone.”
Thus, the SEC rules themselves indicate that a statement or
omission is not necessary to establish a primary violation of
10b-5.
Consistent with the inclusive language of both the statute
and the Rule, the Court has repeatedly emphasized the
extensive anti-fraud purposes of the federal securities laws.
See, e.g., Zandford, 535 U.S. 813 (emphasizing broad
language and interpretation of anti-fraud provisions and
citing cases); United States v. O'Hagan, 521 U.S. 642, 658
(1997) (noting that Congress intended “to insure honest
securities markets and _ thereby promote imvestor
confidence”), Affiliated Ute Citizens, 406 U.S. at 151
(holding that proscriptions of § 10(b) and Rule 10b-5 “are
broad and, by repeated use of the word ‘any,’ are obviously
meant to be inclusive’).
The Court has noted that the 1934 Act and its companion
legislative enactments embrace a “fundamental purpose. . .
to substitute a philosophy of full disclosure for the
philosophy of caveat empior and thus to achieve 1 high
standard of business ethics in the securities industry.” SEC v.
Capital Gains Research Bureau, 375 U.S. 180, 186 (1963).
“17 CE.R. $240.10b-5(c).
20
“We co not think it sound to dismiss a complaint merely
because the alleged scheme does not involve the type of
fraud that is ‘usually associated with the sale or purchase of
securities.””’ Superintendent of Ins. v. Bankers Life & Cas.
Co., 404 U.S. 6, 11 n.7 (1971) (quoting A. 7. Brod & Co. v.
Perlow, 375 F.2d 393, 397 (2d Cir. 1967)). “Novel or
atypical methods should not provide immunity from the
securities laws.” /d. Thus, § 10(b) and Rule 10b-5 prohibit all
fraudulent schemes in connection with the purchase or sale of
securities, even if some of the actors involved did not make
untrue statements or omit to make material statements.
3. Ceutral Bank supports the proposition that actors
using or employing a manipulative or deceptive device
may be liable as primary violators of Section 10(b) or
Rule 10b-5.
Licbility for using or employing a manipulative or
decept ve device is not barred by the Court’s decision in
Central Bank. \|n that case, the parties conceded that the
defendant did not commit any act or practice under § 10(b).
The Contral Bank Court did not explore what constitutes a
primary violation under the statute. See 511 U.S. at 191.
Rather Central Bank held only that liability does not attach
for me ely aiding and abetting a primary violation.
The Central Bank Court expressly said that “[a]ny person
or entity including a lawyer, accountant, or bank, . . . may be
liable as a primary violator under Rule 10b-5.” /d. “The
absenc2 of § 10(b) aiding and abetting liability does not mean
that secondary actors in the securities markets are always free
from liability under the securities Acts.” /d. Even more to the
point, Central Bank did not strike down any language in
§ 10(b: or Rule 10b-5 or sweep away the extremely broad
anti-frz ud purposes of the federal securitics laws.
The Court held in Central Bank only that, to be liable, a
defend int must itself employ one or more of the eight types
21
of manipulative or deceptive devices or contrivances
specified in Rule |0b-5, rather than merely assist ancther in
doing so. In other words, Central Bank concerned the
relationship or connection between the defendant and the
fraudulent conduct; it did not alter the definition of the
fraudulent conduct itself. See id. at 167 (question before
Court was “whether private civil liability under § 10(b)
extends as well to those who do not engage in the
manipulative or deceptive practice, but who aid and abct the
violation”). Central Bank did not address or alter the basic
concept that any person or entity may be liable as a primary
violator of § 10(b) or Rule 10b-5.
Nonetheless, Respondents interpret Central Bunk to
allow an actor to escape liability for participation in a
securities fraud as long as he is crafty enough to carefully
avoid the public attribution to him of a false statement.
Respondents’ interpretation and expansion of Central Bank
will result in virtual immunity from private liability for
culpable banks, law firms, accountants, and other actors in
many cases. And their interpretation directly conflic*s with
both the broad language and purposes of § 10(b) and Rule
10b-5.
Indeed, it is precisely with respect to such schemes that
the anti-fraud provisions are needed the most. The amici
States urge the Court to continue to hold liable those “behind
the scenes” actors who participate in and benefii from
fraudulent schemes but avoid making misleading statements
or omissions.
4. “Non-speaking” actors are subject to primary liability
so long as their own conduct contributing lo the
scheme has a deceptive purpose and effect.
Since Central Bank, the principal duty of the courts in
scheme-liability cases has been to determine what constitutes
a “primary violation” of § 10(¢b). In Central Bank, the Court
2
held that liability under § 10(b) attaches only to “primary
violatc rs” and that there can be no liability for merely “aiding
and atetting” a violation. 511 U.S. at 191. The amici States
urge the Court to set forth a test for such liability based on
two iryportant and discrete showings: first, the defendant
must possess the requisite intent to deceive, i.e., the same
level of scienter required of all primary violators; and second,
the defendant must have actively participated in a scheme
whose principal purpose and effect was to create a false
appearance of fact in furtherance of that scheme.
a. Primary liability under Section 10(b) and Rule
10b-5 may attach to “non-speaking” actors for
false statements and omissions, even if the actors
did not personally make the statement or
omission.
Afr Central Bank, the courts have taken two gencral
approaches to scheme liability under § 10(b)—the
“substantial participation” standard and the “bright line”
standard. Some courts have held that “substantial
participation . .. in the preparation of fraudulent statements ts
grouncs for primary liability even though that participation
might not lead to the actor’s actual making of the [false]
statements.” Howard v. Everex Svs., Inc., 228 F.3d 1057,
1061 n.5 (9th Cir. 2000); see also In re Software Toolworks
Inc. Sec. Litig., 50 F.3d 615, 628-29 (9th Cir. 1994). Under
this “substantial participation” approach, to establish primary
liability for a “non-speaking” actor it must be shown that: (1)
the defendant cither made a misrepresentation or omission, or
“substantially participated” in the preparation of a
misrepresentation made by someone else; and (2) the
defendant knew or should have known that the
misrepresentation or omission would be relied on by
23
investors, but public attribution of the “non-speaking” actor's
. 6
role is unnecessary.
Conversely, under the “bright line” approach, adopted by
the Eighth Circuit below, to establish primary liability it must
be shown that: (1) the defendant itself actually riade a
materially false or misleading statement (or om tted a
materia! fact while under a duty to disclose); (2) the
defendant knew or should have known tht the
misrepresentation or omission would be relicd on by
investors; and, at least according to a few courts, 3) the
misstatement was attributed to the defendant at the time of its
dissemination.
Neither test requires that the alleged violator actually
directly communicate misrepresentations to the plaintiffs. for
primary liability to attach. See Jn re ZZZZ Best Sec. Litig.,
864 F. Supp. 960, 964-72 (C.D. Cal. 1994) (employing
“substantial participation” approach) (“{L]sability under
Section 10(b)/Rule 10b-5 is not limited to the making of
materially false and =misleading statements = or
omissions ....”); Wright v. Ernst & Young LLP, 152 F.3d
169, 171-76 (2d Cir. 1998), cert. denied 525 U.S 1104
(1999) (employing “bright line” approach) (“There is no
requirement that the alleged vielator directly commmicaite
misrepresentations to plaintiffs for primary liabinity to
attach.) (quoting Anixter v. Home-Stake Prod. Co., 77 F.3d
1215, 1225-27 (10th Cir. 1996) (same)). Rather, the
detendant need have only known of recklessly disregarded
** Several federal district cowrts also have adopted this view. S2e. e.g.
Wenneman v. Brown, 49 F. Supp. 2d 1283, 1287-91 (D. Utal 1999):
4elam v. Silicon Valley Bancshares, 884 F. Supp. | 398, 1400 (N_D. Cal.
1995); In ve 2222 Best Sec. Litig., 864 F. Sapp. 960, 971-72 (C.D. Cal.
1994); Hill v. Hanover Energy, Inc., No. 91-1964 GIHG).1991 US. Dist
Lexis 18566 (D.D.C. Dec. 16, 1991), In re Union Carbide Corp.
Consumer Prods. Bus. Sec. Litig , 676 F. Supp. 458, 467-70 (S_DLNLY.
1987).
24
the fact that its misrepresentation or omission would be relied
on by investors. See McGann v. Ernst & Young, 102 F.3d
390, 397 (9th Cir. 1996), cert. denied 520 U.S. 1181 (1997)
(employing “substantial participation” approach); see also
McNainara v. Bre-X Minerals Lid., No. 5:97-CV-159, 2001
U.S. Dist. Lexis 4571, at *131 (E.D. Tex. Mar. 30, 2001)
(emplcying “substantial participation” approach). Thus,
neither test requires that the alleged violator actually directly
commiinicate misrepresentations to plaintiffs for primary
liability to attach. Therefore, some significant role in the
preparition or creation of a misstatement that is directly
communicated to investors by another party can suffice for
primary liability under either post-Central Bank test.
A few “bright line” courts have adopted—with no valid
basis—-the additional requirement that, whether the
defendant's statement is communicated directly to investors
or indirectly through others, the defendant’s statement must
be attr:buted to the defendant by name to be actionable. See
Ziembu v. Cascade Int'l, Inc., 256 F.3d 1194, 1205-12 (11th
Cir. 2001): Wright, 152 F.3d at 171-76. Courts that have
adopted the attribution requirement have done so on the
mistaken assumption that imposing liability on a defendant
when the investors did not know of the defendant's
involvement in the misrepresentation negates the requisite
element of reliance. But that reasoning its flawed. Plaintiffs
certainly can rely on a statement without knowing exactly
who made it. An‘, relianee can exist even when the statement
was not signed by the defendant or when the defendant was
not identified by name.
Moreover, nothing in Central Bank mandates the
conelusion that the concept of “making an untrue statement”
is limited to signing such a statement or having such a
statement identify its speaker by mame. in fact, the Supreme
Court rec@gnized in Central Bank that liability requires
relianc> On @ misrepresentation, not on a misrepresentation
25
that is identified as the statement of a particular persor-: “Any
person or entity, including a lawyer, accountant, ov bank,
who ... makes a material misstatement (or omission) on
which a purchaser or seller of securities relies may be liable
as a primary violator under Rule 10b-5, assuming al/ of the
requirements for primary liability under Rule 10b-5 are met.”
511 U.S. at 191. If the word “indirectly” in § 10(b) ard Rule
|\0b-5 means anything, it certainly should cover the situation
where a defendant creates a misrepresentation but carefully
avoids being publicly identified with it. Fraudulent
misrepresentations should not be immune from liability just
because their creator is concealed. Otherwise, every culpable
“non-speaking” actor would easily avoid liability simply by
conditioning its services en remaining anonymous in any
public statements.
b. Primary liability may attach to a “non-speaking”
acter for participation in a scheme to defraud if
(1) the scheme had the principal purpose and
effect of creating a false appearance of fact and (2)
the actor’s own conduct contributing to the
scheme had a deceptive purpose and effect.
As explained above. § 10(b) specifically authori:zes the
SEC to set forth rules and other interpretive parameters of
§ 10(b)’s reach. Thus, where appropriate, courts show:d look
to and give deference to the Commission’s interpretation of
§ 10(b) as set forth in Rule 10b-5. See Chevron, U.S.A., lic.
v. National Resources Defense Council, Inc., 467 U.'s. 837,
843-44 (1984). Thus, the SEC’s “interpretation >of the
ambiguous text of § I10(b), in the context of formal
adjudication, is entitled to deference if it is reasonable.”
Zarmdford, 535 U.S. at 819-20.
Notably, in the SEC’s amicus brief in Homesicre, on
which the federal district court relied in Furon, the SEC
recognized two points critical to the analysis here. Fi-st, the
26
SEC rooted that “where a wrongdoer, intending to deceive
investors, engages in a deceptive act as part of a scheme to
defraui, he can cause the same injury to investors, and the
same deleterious effects on the market regardless of whether
he designed the scheme.” Newhy v. Enron Corp., No. H-O1-
3624 2006 U.S. Dist. Lexis 43146 at *164-65 (S.D. Tex.
June 5, 2006). And second, the SEC stated that the
“deceptive acts under Section 10(b) include conduct beyond
the making of false statements or misleading omissions, for
facts effectively can be misrepresented by action as well as
by words.” /d.
In its amicus brief, the SEC further claborated that “a
‘deceptive act’ includes a transaction whose principal
purpose and effect is to create a false appearance of revenue
which can be accomplished by acts as well as by words.” /d.
at *167. The Ninth Circuit in Homestore agreed with the
SEC's position that “[a}Jny person who directly or indirectly
engages in a manipulative or deceptive act as part of a
schenu: to defraud can be a primary violator.” 452 F.3d at
1048.
In contrast, the court below adopted a new version of the
‘bright line” test as to scheme liability, whereby “any
defendant who does not make or affirmatively cause to be
made 2 fraudulent misstatement or omission, or who does not
directly engage in manipulative securities trading practices, is
at most guilty of aiding and abetting and cannot be held
liable under § 10(b) or any subpart of Rule 10(b)-5.”
Stonendge. 443 F.3d at 992. But this standard is not
supported by either the text of, or the SEC’s interpretation of,
the statute and rule.
Th: amici States agree with the Ninth Circuit’s
interpretation of §& 10-b and Rule !0b-5 as reflected in the
Homestore opinion. Under that standard, “non-speaking”
actors like Scientific-Atlanta, Motorola, AOL, Cendant, and
27
LYO will be held liable when they actively particiyate in
schemes with both the principal purpose and efiect of
defrauding investors. Unlike the standard adopted by the
Fifth and Eighth Circuits, which allows culpable banks,
lawyers, accountants and others to escape liabil ty for
fraudulent transactions, the Ninth Circuit standard supported
here will deter individuals and companies from engaying in
fraudulent activitics when similar opportunities to defraud
investors arise in the future.
28
CONCLUSION
For the above reasons, amici States ask the Court to
reverse the Eighth Circuit's decision below.
Respectfully submitted,
GREG ABBOTT
Attorn>y General of Texas
DAVID) C. MATTAX
Division Chief
Financial Litigation Division
Office of the Attorney General
P.O. Box 12548
Austin, TX 78711
5$12-4€3-0150
512-477-2348 fax
MARC DANN
Attorney General of Ohio
ELISE W. PORTER*
Acting Solicitor General
*Cou wel of Record
CHRISTOPHER R. GEIDNER
ROBERT J. KRUMMEN
Deputy Solicitors
BETH A. FINNERTY
RANDALL W. KNUTTI
ANDREA L. SEIDT
Assistant Attorneys General
30 E. Broad St., 17th Floor
Columbus, OH 43215
614-466-8980
614-466-5087 fax
Counsel for 4mici States June 11, 2007
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.