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

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No. 06-43 : auG 15 2007 |

OFFICE OF THE CLERK

SUPREME COUPT, U.S.

IN THE -

Supreme Court of the United States

STONERIDGE INVESTMENT PARTNERS, LLC,

Petitioner,

SCIENTIFIC-ATLANTA, INC. and MOTOROLA, INC.,

Respondents.

On WRIT OF CERTIORARI TO THE

UnitrepD STATES COURT OF APPEALS FOR THE EIGHTH CIRCUIT

BRIEF OF THE SECURITIES INDUSTRY AND FINANCIAL

MARKETS ASSOCIATION AND FUTURES INDUSTRY

ASSOCIATION AS AMICI CURIAE IN SUPPORT

OF RESPONDENTS i

IRA D. HAMMERMAN WALTER DELLINGER

Kevin M. Carroui Counsel of Record

SECURITIES INDUSTRY AND O’MELveNny & Myers LLP

FINANCIAL MARKETS ASSOCIATION 1625 Eye Street, NW

1399 New York Avenue, NW Washington, DC 20006

Washington, DC 20006 (202) 383-5300

BARBARA B. WIERZYNSKI JONATHAN ROSENBERG

FUTURES INDUSTRY ASSOCIATION WILLIAM J. SuSHON

2001 Pennsylvania Avenue, NW __ B. ANDREW BEDNARK

Suite 600 O’MELveny & Myers LLP

Washington, DC 20006 7 Times Square

New York, NY 10036

Counsel for Amici Curiae The Securities Industry and Financial

Markets Association and Futures Industry Association

August 15, 2007

TABLE OF CONTENTS

TABLE OF CITED AUTHORITIES ............

INTERESTS OF AMICICURIAE ..............

SUMMARY OF ARGUMENT .................

SEE 6h one renakddsiccsnkaeadesdnses

A NON-DUTY-BASED SCHEME-LIABILITY

REGIME WOULD MULTIPLY LITIGATION

EXPOSURE AND INCREASE THE COST OF

CAPITAL IN U.S. MARKETS ............

Section 10(b) and Rule 10b-5 address

fraud by imposing disclosure duties on

certain market participants ..........

A disclosure triggers a duty to speak

truthfully, but a failure to disclose gives

rise to securities-fraud liability only when

fr re ee

Stoneridge’s non-duty-based Section

10(b) theory would create litigation

exposure to anonymous third-parties;

raising the cost of accessing the U.S.

capital markets without benefiting

Er PP eee rae

D. In contrast to the clear standard that the

duty requirement provides, Stoneridge’s

proposed “purpose and effect” test would

create uncertainty and roll back

Congress’s consistent post-Central Bank

efforts to limit private securities class

RT kg KS wre Cha dep Ree een ss cee

Il. EXISTING FEDERAL AND STATE LAWS

PROVIDE ADEQUATE DETERRENCE

AGAINST POTENTIAL AIDERS AND

ABETTORS AND AMPLE INVESTOR

PE nb btn pindum on caunk en

A. Federal criminal penalties are a

professional death sentence for most

secondary actors, including financial

EE id ewe racadusveueeeieees

B. The SEC has responded to Congress’s

decision to expand its—and not private

plaintiffs’°—enforcement and recovery

NE Sree i oi ba FERC C TERN OEE KI

C. State penalties and recovery methods

broadly encompass aiding and abetting

securities-law violations ............

en er per ree

Page

iil

TABLE OF CITED AUTHORITIES

CASES

Affiliated Ute Citizens of Utah v. United States,

, TESS Se es eae eeee

Archdiocese of Milwaukee Supporting Fund, Inc.

v. Halliburton Co.,

No. 02-CV-1152-M (N.D. Tex. Feb. 28, 2007) ..

Arthur Andersen LLP v. United States,

Basic Inc. v. Levinson,

EE a bn on ce ode he 0b ten obade

Berkowitz v. Lyons,

eS FRE ee

Blue Chip Stamps v. Manor Drug Stores,

EE Sv cab eb ice cen dtevecanee

Cent. Bank of Denver, N.A.

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

ST UD. BGO CTIDE) .. 2. eee eee e erences

Chiarella v. United States,

ee i cleebheeeeae

Dirks v. SEC,

ee ha cee teense

Dist. Motor Co. v. Rodill,

88 A.2d 489 (D.C. Ct. App. 1952) ............

Page

In re Dynegy, Inc. Sec. Litig.,

339 F. Supp. 2d 804 (S.D. Tex. 2004) ......... 16

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

Fe Fee Pe Ce BOOED wh ccd cncccccece 5

Ganino v. Citizens Util. Co.,

ee ie CS ED bv ceo ceccvvceacen 7

Lindberg Cadillac Co. v. Aron,

371 S.W.2d 651 (Mo. Ct. App. 1963) ......... 12

In re Medtronic, Inc. Implantable

Defibrillator Prod. Liab. Litig.,

05-MDL-1726-JMB-AJB

Sk EE 0 <.6.0464 nivancedoeeoune 23

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

Per a CREE bc kt biedncnindiese wun 20

In re New Motor Vehicles Can. Exp. Antitrust Litig.,

03-MDL-01532-DBH (D. Me. Dec. 18, 2006) ... 23

In re Parmalat Sec. Litig.,

376 F. Supp. 2d 472 (S.D.N.Y. 2005) .......... 15,19

Pinter v. Dahl,

— Tk Df errr eerrcre rere 17, 18

Regents of the Univ. of Cal.

v. Credit Suisse First Boston (USA), Inc.,

Pe be ts ot i wrrrrer erry 9,15

Page

Rubin v. Schottenstein, Zox & Dunn,

143 F.3d 263 (6th Cir. 1998) ................ 8

Sachs v. Blewett,

[UD . . scscvccecessoeceus 12

Salzman v. Maldaver,

24 N.W.2d 161 (Mich. 1946) ................ 12

Santa Fe Indus., Inc. v. Green,

EEE OTE TTT TET ET 6

Schreiber v. Burlington N., Inc.,

CO ee 5

SEC v. Capital Gains Research Bureau, Inc.,

> Sk ef ae ANE ar 5

SEC v. Zandford,

ete e escent ieu's¢~es 7, 10

Simpson v. AOL Time Warner Inc.,

452 F.3d 1040 (9th Cir. 2006) ............... 15

State v. McLeod,

12 Misc. 3d 1157(A), 2006 WL 1374014

EE cece ceeesecceeressocess 29

Stewart v. Wyo. Cattle Ranche Co., Lid.,

EL ll

)

In re Syntex Corp. Sec. Litig.,

855 F. Supp. 1086 (N.D. Cal. 1994) ........... x

Tellabs, Inc. v. Makor Issues & Rights, Lid.,

United States v. Barford,

No. 4:03CR00434 (E.D. Mo. Apr. 22, 2005) ....

United States v. Colton,

231 F.3d 890 (4th Cir. 2000) ...............

United States v. Kalkwarf,

No. 4:03CR434 (E.D. Mo. Apr. 22, 2005) .....

United States v. McCall,

No. 4:03CR434 (E.D. Mo. Apr. 22, 2005) .....

United States v. O’Hagan,

a i cumeeean

United States v. Smith,

No. 4:03CR434 (E.D. Mo. Apr. 22, 2005) .....

ADMINISTRATIVE CASES

In re Cady, Roberts & Co.,

GOGO CUUHIOIE occ cick cacccecccascss

Dep t of Enforcement v. J. Alexander Sec., Inc.,

CA F010021, 2004 NASD Discip. LEXIS 16

Sh nD. «} cages o6b6 eek e0iCK64 ee 8s

Dept of Enforcement v. Perles, CA F980005,

2000 NASD Discip. LEXIS 9 (Aug. 16, 2000) ..

vii

Page

In re Faberge, Inc.,

PRED cccccdénscocanececteces 13

In re Merrill Lynch, Pierce, Fenner & Smith, Inc..,

ED cid wetepegbsennedsess 10

In re Motorola, Inc., SEC Exchange Act Release

No. 55,725 (May 8, 2007), available at http://

www.sec.gov/litigation/admin/2007/

EE, ioc eth ddiweebdancuneteces 27

SEC v. Christian, SEC Litig. Release No. 19294

(Jul. 7, 2005), available at http://www.sec.

gov/litigation/litreleases/Ir19294.htm ......... 30

SEC v. J.P. Morgan Chase & Co., SEC Litig. Release

No. 18252 (Jul. 28, 2003), available at http://

www.sec.gov/litigation/litreleases/Ir18252.htm ...

SEC v. Scientific-Atlanta, Inc., SEC Litig. Release

No. 19735 (Jun. 22, 2006), available at http://

www.sec.gov/litigation/litreleases/2006/

RCN eta ree ts 99 poe aR eR

SEC v. Southmark Advisory, Inc., SEC Litig. Release

No. 17818 (Oct. 30, 2002), available at http://

www.sec.gov/litigation/litreleases/Ir17818.htm ...

vili

Page

STATUTES

PE WEED ches 6 Se cneentess davassenen 20

i, cre cecedeneanwackheeeneadus 6

15 U.S.C. i cckhweegkee bes sauneasenes - 27

EE Ki. 0s'od450660456005000068 20, 25, 27

Se See PEERS cc cceccceccesucecces 15

i 2d ci cae de kcenaceadanns 21

ie ee ENED. cvccccocuscenccsesee 27

PEE ct06604bdb60eeeneanesbasnud 25

Re re ree 21

DEE Svahsdnieekedsenentececeeveewes 22, 25

SN eee rereeriyver erry TT ey rere 22, 25

18 U.S.C. § SVEN IMD) SCE) .. cc ccccccccss 22

CE cvs csedenedende0eeeaeteuens 25

PE weechevovencebaceaveveceass 25

ie cttns (ebecebaee betes aus ie 12

I 22

ee eee GI, GUE, BES oc cc cccccccccseccces

Cal. Corp. Code § 25403(b) ...................

Cal. Corp. Code §§ 25540-25542 ..............

Cal. Corp. Code §§ 25530-25536 ..............

Del. Code Ann. tit. 6, § 7325 ..................

N.Y. Gen. Bus. Law, Art. 23-A § 352(1) .........

N.Y. Gen. Bus. Law, Art. 23-A § 352-c(2) ........

N.Y. Gen. Bus. Law, Art. 23-A § 352-c(4){(6) ....

N.Y. Gen. Bus. Law, Art. 23-A § 352-d ..........

N.Y. Gen. Bus. Law, Art. 23-A § 358 ............

Sarbanes-Oxley Act of 2002,

Pub. L. No. 107-204, § 3 (2002) .............

RULES

17 CER. § 240.10b-5(a) 2.2.2. e cece eee eee

17 C.E.R. § 240.10b-5(b) 20... e eee eee ce eee

IFCPR. ODO S-Se) ......... 2.20.00 000:.

17 C.F.R. § 240.13b2-2(b)(1) .. 0. eee eee eee eee

Page

28, 29

Page

LEGISLATIVE AND ADMINISTRATIVE

MATERIALS

SO CE, CUE an vee cc cesesvcccoecuses 20

145 Comm, Ree. BESTSGS 2. ww ccc ccc ccsseccess 21

H.R. Rep. No. 104-50 (1995) .................. 15

H.R. Rep. No. 104-369 (1995) ................. 20

H.R. Rep. No. 107-414 (2002) .............. pies 21

Improper Influence on Conduct of Audits, Exchange

Act Release No. 34—47890, Investment Company

Act Release No. 26,050, 68 Fed. Reg. 31820

I die i ie BE he is a Rea ey ki 27

S. Rep. No. 104-98 (1995), reprinted in

pops oe Se rae 20

OTHER AUTHORITIES

John C. Coffee, Jr., Reforming the Securities

Class Action: an Essay on Deterrence and Its

Implementation, 106 Colum. L. Rev. 1534

DE bcd tena chee beenas Rca ha renee 17

Paul Davies, Spitzer's Successor May Not Follow in

His Footsteps—Cuomo Targets Medicaid Fraud,

Guns, Government Corruption; Grasso Case Will

Be Early Test, Wat St. J., Nov. 11, 2006 ...... 29

Page

Kurt Eichenwald, Brokerage Firm Admits Crimes in

Energy Deals, N.Y. Times, Oct. 28, 1994 ....... 22

Jonathan D. Glater, Last Task at Andersen: Turning

Out the Lights, N.Y. Times, Aug. 30,2002 ...... 23

Interim Report of the Committee on Capital Markets

Regulation (2006), available at http://www.

capmktsreg.org/pdfs/11.30Committee_Interim_

in och ote eke cee bees pecwrans 15, 16

Key Events in the Prosecution, N.Y. Times, Apr. 21,

Dt dhttgibeedess4e4¢cens ee sutebeeswnece 23

Peter Krouse, Ohio Gains $144 Million for Pensions

in Settlement, CLEVELAND PLAIN DEALER, Mar. 8,

DE imiiberceteeteddneueteaeteudesawes 26

N.Y. State Common Ret. Fund Asset Listing as of

March 31, 2006, available at http://www.osc.state.

ny.us/retire/word and _pdf_documents/publications/

cafr/asset_listings 06.pdf................... 17

Opening Remarks by Treasury Secretary Henry M.

Paulson, Jr. at Treasury’s Capital Markets

Competitiveness Conference (Mar. 13, 2007), http:

//www.ustreas.gov/press/releases/hp306.htm .... 17

Press Release, U.S. Dep’t of Justice, America Online

Charged with Aiding and Abetting Securities Fraud

(Dec. 15, 2004), available at http://www.fbi.gov/

dojpressrel/pressrel04/aolrelease121504.htm ... 24

xii

Press Release, U.S. Dep’t of Justice, Canadian

Imperial Bank of Commerce Agrees to Cooperate

with Enron Investigation (Dec. 22, 2003),

available at http://www.usdoj.gov/opa/pr/2003/

December/ 03 crm_718.htm ............665:.

Press Release, N.Y. State Att’y Gen., Former Trust

Company Officials Arrested in Late Trading Fraud

(Nov. 25, 2003), available at http://www.oag.

state.ny.us/press/2003/nov/nov25a_03.html ....

Press Release, Office of Rep. Richard H. Baker, U.S.

House of Representatives, Returning Funds to

Defrauded Investors (Jul. 17, 2002) ...........

David Reilly, Narrow Escape: How a Chastened

KPMG Got by Tax-Shelter Crisis — Boss of Just

Three Days Admitted Firm’s Sins, Fought to Keep

Clients, Watt St. J., Feb. 15,2007 ...........

Reply Br. of Lead Pl. in Support of Mot. for

Substitution of Lead Counsel, Archdiocese of

Milwaukee Supporting Fund, Inc. v. Halliburton Co.,

No. 02-CV-1152-M (N.D. Tex. Dec. 27, 2006) ....

Restatement of Torts (Second) § 525 ............

Restatement of Torts (Second) § 550 ............

Restatement of Torts (Second) § 551(2)(a) .......

Page

xiii

Page

Securities & Exchange Commission, 2006

Performance and Accountability Report, available

at http://www.sec.gov/about/secpar2006.shtml ... . 26

U.S. Dep’t of Justice, Fact Sheet: Corporate Fraud

Task Force (Aug. 9, 2006), available at http://

www.usdoj.gov/opa/pr/2006/August/06_odag _

EE Whee eorkas cxdeeneeanevasutacedanes 22

Pat Widder, Timing Helps Salomon Beat Drexel’s

Fate, Cui. Trip., May 24, 1992 ............... 23

INTERESTS OF AMICI CURIAE '

Amicus SIFMA brings together the shared interests of more

than 650 securities firms, banks, and asset managers that have

a vital interest in the outcome of this appeal. These institutions

are the gateway to the U.S. capital markets, linking thousands

of companies to millions of investors. Among other things, they

underwrite equity and debt offerings for domestic and foreign

issuers, broker securities trades, provide financial advisory

services, publish analysis, lend money to companies ranging

from small start-ups to the Fortune 100, and make private-equity

investments in large and small companies. In short, these

financial institutions are essential to every aspect of the U.S.

(and global) capital markets’ function. SIFMA’s mission is to

promote policies and practices that expand and perfect markets,

foster the development of new products and services, and create

efficiencies for member firms, while preserving and enhancing

the public’s trust and confidence in the markets and the industry.

SIFMA works to represent its members’ interests locally and

globally through offices in New York, Washington, D.C., and

its associated firm, the Asia Securities Industry and Financial

Markets Association, in Hong Kong.

Amicus FIA is a national trade association for the

commodity futures and options industry. Its regular membership

consists of 35 of the nation’s largest futures brokerage firms,

and its associate membership consists of approximately 150

firms involved in virtually all other segments of the industry.

‘Many of FIA’s members also -are- securities. broker-dealers,

investment banks, commercial-bank affiliates, or are otherwise

extensively involved in capital market and business transactions.

' Letters of consent from both parties have been filed with the

clerk. The Securities Industry and Financial Markets Association

(“SIFMA”) and the Futures Industry Association (“FIA”) state that under

Rule 37.6, no counsel for a party authored this brief in whole or in part.

No person or entity other than SIFMA, FIA, their members, or counsel

made a monetary contribution to this brief’s preparation or submission.

This case is enormously important to these financial

institutions and the U.S. capital markets. Much like the vendors

that petitioner Stoneridge Investment Partners (“Stoneridge”)

sued in this case, financial institutions routinely provide a broad

range of services to and engage in counterparty transactions

with public issuers. If Stoneridge’s positions were accepted,

these institutions would face unprecedented liability risk and

litigation expense from private securities-fraud litigation brought

by shareholders of issuers that later misreport those transactions

in their financial statements. Nothing in the relevant statutory

framework, caselaw, or public policy supports such a result.

SUMMARY OF ARGUMENT

The federal securities laws guard against fraud by imposing

duties on certain parties in certain contexts to disclose material

information. But those duties do not apply equally to all

commercial actors. In Central Bank of Denver, N.A. v. First

Interstate Bank of Denver, N.A.,’ for example, the Court held

that Section 10(b) does not give rise to “aiding-and-abetting”

or conspiracy liability.? And since 1994, Congress has

consistently reaffirmed Central Bank’s wisdom by amending

the statute to empower only the SEC to sue securities-fraud

aiders and abettors, while further restricting Section 10(b)’s

implied private right of action.

Foreshadowing cases like this one, the Central Bank dissent

correctly predicted that private plaintiffs would recast aiding-

and-abetting allegations as primary violations:

[MJany aiders and abettors will be subject to liability

as primary violators. For example, an accountant,

lawyer, or other person making oral or written

misrepresentations (or omissions, if the person owes

a duty to the injured purchaser or seller) in

connection with the purchase or sale of securities

2 S511 U.S. 164 (1994).

3 See id. at 177-78.

may be liable for a primary violation of § 10(b) and

Rule 10b-5.4

Thus, the dissent recognized the settled law that a silent

secondary actor’s failure to disclose could constitute a primary

Section 10(b) violation only if the actor had a duty to disclose.

If Section 10(b) did not require that duty as a condition to

liability in the nondisclosure context, every routine commercial

or financial transaction with a public issuer would become a

minefield of private securities-fraud liability exposure. Once

an issuer misreports the transaction, shareholder-plaintiffs could

sue every anonymous third party that played a role, even if that

party never uttered a word publicly. The resulting specter of

Rule 10b-5 liability would force every commercial actor to

disclose all material information to every other counterparty

and its shareholders or other constituents. In this case, the only

way that Scientific-Atlanta and Motorola could have protected

themselves from potential liability would have been to leapfrog

Charter and make a specific disclosure (possibly violating a

confidentiality agreement) to Charter 's shareholders, complete

strangers with whom Scientific-Atlanta and Motorola otherwise

would never have interacted or communicated.

That is why Stoneridge’s scheme-liability theory fails. The

duty to make truthful disclosures to Charter’s shareholders

belonged exclusively to Charter, and thus only Charter could

have breached that duty in violation of Section 10(b). At most,

Scientific-Atlanta’s and Motorola’s alleged participation in sham

transactions that Charter used to falsify its financials may

constitute aiding and abetting securities fraud. But absent their

Own misstatements or a duty to speak, Scientific-Atlanta and

Motorola cannot be found to have committed primary Section

10(b) violations.

Eliminating the duty requirement would especially

prejudice financial institutions that routinely provide financial

services to or engage in counterparty transactions with public

* Id. at 199 n.10 (citations omitted) (emphasis added).

issuers. These institutions would effectively be charged with

ensuring the issuers’ compliance with federal securities laws.

Unless the financial institutions prepared their own disclosures

(or closely supervised their clients’ disclosures), they would

regularly face exposure to classes of securities holders to whom

they never made any statements or owed any duties, and with

whom they never transacted business. The ripple effects of such

a regime—which several lower courts adopted after Central

Bank—are living proof of the harm to the very investor-base

that Stoneridge and its amici claim to champion. Added

transaction and compliance costs put the U.S. capital markets

out of reach (or at least make them unattractive) for many issuers

and increase the cost of capital prohibitively for many others,

driving them to foreign markets and deterring foreign issuers

from raising capital in the U.S. The result is fewer opportunities

for American investors.

Contrary to Stoneridge’s and its amici’s shrill cry, an

affirmance here would not encourage financial institutions to

participate in sham transactions that issuers might use to falsify

their financial statements. Financial institutions already face

serious consequences for aiding and abetting an issuer’s

securities-law violations. First and foremost, they can be put

out of business as a practical consequence of criminal

prosecution. They can also be sued by the SEC or self-regulatory

organizations (SROs) (for aiding and abetting the issuer’s fraud,

or for violating other rules and regulations applicable to financial

institutions), and by state regulators and attorneys general (under

broad anti-fraud statutes like New York’s Martin Act). There is

thus no need to distort Section 10(b)’s longstanding duty

requirement by recharacterizing classic aiding-and-abetting

conduct as a “primary violation.”

ARGUMENT

I. A NON-DUTY-BASED SCHEME-LIABILITY

REGIME WOULD MULTIPLY LITIGATION

EXPOSURE AND INCREASE THE COST OF

CAPITAL IN U.S. MARKETS.

At bottom, Stoneridge’s espoused theory of “scheme

liability” is nothing more than an impermissible private right

of action for aiding and abetting securities fraud. Indeed, the

Tenth Circuit Court of Appeals in Central Bank found the bank’s

“affirmative” participation in the issuer’s “fraudulent scheme”

to constitute aiding and abetting (which the court erroneously

concluded was actionable).* Nonetheless, Stoneridge argues that

its allegations regarding Scientific-Atlanta’s and Motorola’s

alleged affirmative participation in Charter’s fraudulent scheme

fit within Central Bank’s description of a “primary” violation.

This argument fails because Stoneridge cannot allege against

Scientific-Atlanta and Motorola Section 10(b)’s central

requirement—a duty to disclose.

A. Section 10(b) and Rule 10b-5 address fraud by

imposing disclosure duties on certain market

participants.

The Court has repeatedly observed that the securities laws’

“fundamental purpose” is to promote “full disclosure.” ° Section

10(b) furthers that purpose by prohibiting the use or employment

of “any manipulative or deceptive device or contrivance in

’ First Interstate Bank of Denver, N.A. v. Pring, 969 F.2d 891,

895, 902 (10th Cir. 1992) (sustaining aiding-and-abetting claim against

Central Bank where plaintiffs had alleged that securities “were sold as

part of a fraudulent scheme” that Central Bank assisted “by affirmative

action, specifically by affirmatively agreeing to delay the independent

review of the” property appraisal).

® See, e.g., Cent. Bank, 511 U.S. at 171; Schreiber v. Burlington

N., Inc., 472 U.S. 1, 8 (1985); Affiliated Ute Citizens of Utah v. United

States, 406 U.S. 128, 151 (1972); SEC v. Capital Gains Research Bureau,

Inc., 375 U.S. 180, 186 (1963).

contravention of such rules and regulations as the [SEC] may

prescribe.” ’

SEC Rule 10b-5 and its three subsections effectuate this

mandate. Specifically, Rule 10b-5(b) bars incorrect and

incomplete disclosure by imposing a duty on speakers to be

truthful and complete—it prohibits “any untrue statement of

material fact” or omission “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.” *

Rules 10b-5(a) & (c), in contrast, address conduct that does not

involve speaking, and thus apply even where there is no

disclosure. They prohibit “any device, scheme, or artifice to

defraud”’ and “any act, practice, or course of business which

operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.” '°

The failure to disclose is essential to Rule 10b-5(a) & (c)

liability because there can be no “fraud or deceit” where the

nature of the “device, scheme, or artifice” is fully disclosed. In

Santa Fe Industries, Inc. v. Green, for example, the plaintiff

shareholders were “furnished with all relevant information on

which to base their decision” either to approve a proposed short-

form merger or reject it and exercise their share-appraisal

rights.'' Because “the complaint failed to allege a material

misrepresentation or material failure to disclose,” the transaction

was “neither deceptive nor manipulative and therefore did not

violate either § 10(b) of the Act or Rule 10b-5.”? Just as full

’ See 15 U.S.C. § 78}(b) (2007).

® 17C.F.R. § 240.10b-5(b) (2007).

° Id. § 240.10b-5(a).

" 430 U.S. 462, 474 (1977).

2 Id.; see also United States v. O'Hagan, 521 U.S. 642, 655 (1997)

(“{F]ull disclosure forecloses liability under the misappropriation

theory, [of insider trading]: Because the deception essential to the

(Cont'd)

disclosure precludes a fraud claim, the failure to disclose can

create one. The Court first made this observation in Affiliated

Ute Citizens v. United States, when it found that the acts of the

defendants—bank employees who had contracted to facilitate

Ute tribe members’ stock sales to outsiders (including the

defendants themselves)}—“operated as a fraud . . . because the

defendants devised a plan and induced the [plaintiffs] to dispose

of their shares without disclosing to them material facts that

reasonably could have been expected to influence their decisions

to sell.” ’ Regardless of the specific “act, practice, or course of

business” * that brought the defendants within the rule, it was

their failure to disclose that rendered their conduct fraudulent.

Nondisclosure also underlies the fraud alleged here.

As Stoneridge’s amici concede, “had the truth behind Charter’s

financial statements been disclosed, there would have been no

injury.” '° That is, had Charter announced the terms of its

transactions with Scientific-Atlanta and Motorola (rather than

just Charter’s revenue data), the market would have recognized

the transactions for what they were.'® Thus, the transactions

(Cont'd)

misappropriation theory involves feigning fidelity to the source of

information, if the fiduciary discloses to the source that he plans to

trade on the nonpublic information, there is no ‘deceptive device’ and

thus no § 10(b) violation . . . .”).

' 406 U.S. 128, 153 (1972) (emphasis added); see also SEC v.

Zandford, 535 U.S. 813, 820-21 (2002) (“Taking the allegations in the

complaint as true, each sale was made to further respondent’s fraudulent

“scheme; each was deceptive because it was neither authorized by, nor

disclosed to, the {client].”) (emphasis added).

4 17 C.F.R. § 240.10b-5(c) (2007).

'S Br. for Amici Curiae States of Ark. et al. in Support of Petitioner

at 14 n.4.

'© See, e.g., Ganino v. Citizens Util. Co., 228 F.3d 154, 167 (2d

Cir. 2000) (explaining that under “truth on the market” corollary to

“fraud on the market” doctrine, “a misrepresentation is immaterial

(Cont'd)

themselves did not result in any fraud—rather, investors were

allegedly defrauded by Charter’s later misrepresentations about

the transactions. In amici’s words, “the plaintiffs’ injuries are

ultimately traceable to the false statements that Charter issued.”"”

B. A disclosure triggers a duty to speak truthfully, but

a failure to disclose gives rise to securities-fraud

liability only when it breaches a duty.

Fraud thus boils down to either a knowingly false or

misleading disclosure, or a failure to disclose. Charter’s false

statements were fraudulent because Rule 10b-5(b) imposes a

duty on speakers to disclose accurately and completely."* In Rule

10b-5(a) and (c) cases involving conduct, not speech, fraud arises

from the defendant’s failure to disclose his actions.'? But when

a defendant has made no false or misleading statements to

investors, silence can give rise to fraud liability only when the

defendant breaches a duty to speak. Thus, in Chiarella v. United

States, the Court found that Section 10(b) incorporated the

(Cont'd)

if the information is already known to the market because the

misrepresentation cannot then defraud the market”); cf Basic Inc. v.

Levinson, 485 U.S. 224, 248 (1988) (holding that presumption of reliance

in a fraud-on-the-market case may be rebutted by proving that “the

‘market makers’ were privy to the truth”); Jn re Syntex Corp. Sec. Litig.,

855 F. Supp. 1086, 1094 (N.D. Cal. 1994) (holding that defendant’s

truthful disclosure of its financial results relieved it of any duty to

characterize those results).

' Br. for Amici Curiae States of Ark. et al. in Support of Petitioner

at 17.

'8 See, e.g., Rubin v. Schottenstein, Zox & Dunn, 143 F.3d 263,

268 (6th Cir. 1998) (holding that Rule 10b-5(b) imposes a duty “to

provide complete and non-misleading information with respect to

subjects on which [a speaker] undertakes to speak”).

'° See Br. for Amici Curiae States of Ark. ef al. in Support of

Petitioner at 14 n.4 (“Because the securities laws are fundamentally

directed at disclosure, at bottom, every injury premised on affirmative

conduct can be reduced to a failure to disclose.”) (citations omitted).

common-law principle that “one who fails to disclose material

information prior to the consummation of a transaction commits

fraud only when he is under a duty to do so.””

This duty is essential to any nondisclosure-based Section

10(b) claim. It renders the nondisclosure “deceptive” because

the plaintiff is entitled to rely on the defendant for complete

information.”' In contrast, Stoneridge’s “scheme” theory—also

based on nondisclosure—would impose primary fraud liability

on defendants that not only made no disclosures to shareholders,

but also owed those shareholders no disclosure duty at all.

As the Court has noted (and rejected), such duty-divorced

liability would amount to “recognizing a general duty between

all participants in market transactions” to disclose all material,

nonpublic information or to forgo their transactions entirely.”

To say instead that the disclosure duty arises from

“conduct” likewise eradicates the duty requirement altogether,

because an issuer’s counterparties always engage in some

“conduct”—whether they are buying goods, selling advertising,

making loans, or structuring a transaction. By alleging

undisclosed “conduct” as “primary” fraud—such as by artfully

445 U.S. 222, 228 (1980).

2 See id. at 234-35 (“Section 10(b) is aptly described as a catchall

provision, but what it catches must be fraud. When an allegation of fraud is

based upon nondisclosure, there can be no fraud absent a duty to speak.”);

Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA), Inc., 482

F.3d 372, 385 (Sth Cir. 2007). The court in Regents concluded:

It is natural to expect a plaintiff to rely on the candor of

one who owes him a duty of disclosure, and it is fair to

force one who breached his duty to prove that the plaintiff

did not so rely. Here, however, where the plaintiffs had no

expectation that the banks would provide them with

information, there is no reason to expect that the plaintiffs

were relying on their candor.

Id.

2 Chiarella, 445 U.S. at 233.

®% See Br. for Amici Curiae States of Ark. ef al. in Support of

Petitioner at 19.

pleading a legitimate transaction as a pejorative “sham”—private

plaintiffs simply end-run and effectively eliminate the

requirement for a preexisting duty. The resulting dutiless

securities-fraud regime, and the expansive liability that would

follow, are precisely what the statute does not authorize and

this Court has repeatedly rejected.”

Instead, the Court has sought only to prevent the “inherent

unfairness” *’ of parties exploiting, while failing to disclose,

information to which they were afforded special access. In

Chiarella, the Court adopted the Restatement of Torts’ common-

law formulation that, absent any false statements, a duty to

disclose exists only “when one party has information ‘that the

other [party] is entitled to know because of a fiduciary or other

similar relation of trust and confidence between them.’ ” * Thus,

the duty to disclose “arises from a specific relationship between

two parties.”*’ That relationship may exist among corporate

insiders and shareholders” or brokers and their clients,” but it

does not exist between a corporation’s shareholders and

* See Dirks v. SEC, 463 U.S. 646, 654-55 (1983) (observing that

“[njot to require” a disclosure duty arising from a fiduciary relationship

“would amount to ‘recognizing a general duty between all participants

in market transactions to forgo actions based on material, nonpublic

information’ ”) (quoting Chiarella, 445 U.S. at 233); id. at 657 (rejecting

“idea that the antifraud provisions require equal information”); Chiarella,

445 U.S. at 233 (“Formulation of such a broad duty . . . should not be

undertaken absent some explicit evidence of congressional intent. As

we have seen, no such evidence emerges from the language or legislative

history of § 10(b).”).

25 See Inre Merrill Lynch, Pierce, Fenner & Smith, Inc., 43 S.E.C.

933, 936 (1968).

of Torts § 551(2)(a) (1976)).

27 Id. at 233 (emphasis added).

% See, e.g., id. at 228 (citing In re Cady, Roberts & Co., 40 S.E.C.

907 (1961)).

* See, e.g., SEC v. Zandford, 535 U.S. 813, 823 (2002).

commercial third parties, such as the corporation’s financial-

services providers or its third-par:y vendors. Like the financial-

printer employee in Chiarella, Scientific-Atlanta and Motorola

were “complete stranger{s]” who never interacted with Charter’s

shareholders.” Imposing a duty to disclose to such remote parties

would “depart[] radically from the established doctrine” and

“should not be undertaken absent some explicit evidence of

congressional intent,” which, as the Court noted in Chiarella,

does not exist.”!

Amici Change to Win and the CtW Investment Group

incorrectly rely on the common-law general “duty not to

deceive.”*? As both the Court and the Restatement have

acknowledged, that duty runs at most only to counterparties in

business transactions—not to unidentified third parties (like the

counterparty’s shareholders) with whom the defendant never

interacted or communicated.*? The Fourth Circuit in United

selling shareholders’] agent, he was not a fiduciary, he was not a person

in whom the sellers had placed their trust and confidence. He was, in

fact, a complete stranger who dealt with the sellers only through

impersonal market transactions.”).

" Id. at 233.

2 See Br. for Change to Win & the CtW Inv. Group as Amici

Curiae in Support of Petitioner at 16 (“Common law fraud also includes

acts taken to conceal, create a false impression, mislead, or otherwise

deceive in order to ‘prevent[] the other [party] from acquiring material

information,’ even in the absence of a fiduciary, statutory, or other

independent duty to disclose material information:”) (citation omitted);

Br. of the Am. Ass’n for Justice as Amicus Curiae in Support of Petitioner

at 14.

3 See Stewart v. Wyo. Cattle Ranche Co., Ltd., 128 U.S. 383, 388

(1888) (“The gist of the action [for common-law fraud] is fraudulently

producing a false impression upon the mind of the other party . . . .”)

(emphasis added); Restatement (Second) of Torts § 550 (1977) (“One

party to a transaction who by concealment or other action intentionally

prevents the other from acquiring material information is subject to the

same liability . . . .”) (emphasis added).

States v. Colton® reached the same result in construing the same

words in the federal bank-fraud statute on which Stoneridge

relies here—‘scheme or artifice to defraud.”** The court applied

the common-law rule to conclude that the defendant had directly

deceived his counterparty, the Resolution Trust Corporation,

by failing to disclose material facts that allowed him to purchase

a defaulted note at a discount.* Thus, contrary to amici’s

urging,*’ Colton’s logic is no broader than the common law and,

even if it applied to Rule 10b-5(a)’s similar language, would

not reach defendants who never interacted or communicated

with the complaining shareholders.

The common-law cases likewise consistently impose

disclosure duties only on business adversaries.** Thus, under

the common-law rule, Scientific-Atlanta’s and Motorola’s “duty

not to deceive” would run to Charter—their business

counterparty—not to anonymous Charter shareholders with

whom they never interacted or communicated.*? Even Change

to Win’s far-afield example of a car dealer resetting an odometer

to deceive a buyer illustrates this limitation.“ The dealer’s

4 231 F.3d 890 (4th Cir. 2000).

3S See 18 U.S.C. § 1344 (2007).

%®© See Colton, 231 F.3d at 896-99.

” See Br. for Change to Win & the CtW Inv. Group as Amici

Curiae in Support of Petitioner at 5, 13, 16 & 22.

*® See, e.g., Salzman v. Maldaver, 24 N.W.2d 161 (Mich. 1946)

(aluminum seller concealed corroded sheets from buyer and interfered

with buyer’s ability to inspect); Lindberg Cadillac Co. v. Aron, 371

S.W.2d 651 (Mo. Ct. App. 1963) (seller painted over engine-block crack

to conceal it from buyer); Berkowitz v. Lyons, 119 A. 20 (N.J. 1922)

(seller sold buyer stolen automobile).

% See, e.g., Sachs v. Blewett, 185 N.E. 856, 858 (Ind. 1933)

(dismissing fraud claim where complaint did not allege “any relationship

of trust or confidence between the parties, nor are any circumstances

shown which would entitle the [plaintiff] to place more than ordinary

reliance in the promises of the [defendants]”).

“ See Dist. Motor Co. v. Rodill, 88 A.2d 489, 494 (D.C. Ct. App.

1952); Restatement (Second) of Torts § 525 cmt. b (1977).

duty—to disclose the reset odometer or abstain from selling the

car—tuns only to the buyer, not to the buyer’s constitu€nts or

subsequent counterparties. This is similar to the duty to disclose

or abstain that the Court has held must arise from a “specific

relationship between two parties.” *' And of course, the odometer

example is several steps removed from this case—unlike the

car dealer whose conduct amounts to an affirmative

representation about the car under his control, Charter’s third-

party vendors made no representations (through either words

or conduct) to Charter’s shareholders and did not control the

contents of Charter’s financial statements.

C. Stoneridge’s non-duty-based Section 10(b) theory

would create litigation exposure to anonymous

third-parties, raising the cost of accessing the U.S.

capital markets without benefiting investors.

Abandoning the duty to disclose as a prerequisite to Section

10(b) liability would expose literally all participants in

commercial transactions with public issuers to private securities-

fraud litigation—even if they never deceived anyone or uttered

a word publicly. For financial institutions, which collectively

do business with virtually every company seeking access to the

U.S. capital markets, the consequences of Stoneridge’s non-

duty theory would be especially acute. It would force them to

police issuers’ disclosures for accuracy and completeness or,

worse, implement their own disclosure regime for every

transaction with a public company.* It would also place financial

institutions in the impossible role of assessing a disclosure’s

materiality to their counterparty'’s shareholders while lacking

4! Chiarella, 445 U.S. at 233.

® See Dirks v. SEC, 463 U.S. 646, 653 n.12 (1983) (“The SEC

views the disclosure duty as requiring more than disclosure to purchasers

or sellers: ‘Proper and adequate disclosure . . . can only be effected by

a public release through the appropriate public media, designed to

achieve a broad dissemination to the investing public generally and

without favoring any special person or group.’ ”) (quoting /n re Faberge,

Inc., 45 S.E.C. 249, 256 (1973)).

complete and accurate information themselves. Setting aside

the potential exposure to the counterparty that a misinformed

disclosure could create, and the practical conflict if the

counterparty were to insist on typical confidentiality protections,

such a result would only harm investors by burying them in an

avalanche of countless, potentially conflicting disclosures from

an issuer’s commercial counterparties. As the Court has

observed, such information-overload is “hardly conducive to

informed decision making.” ”

In other words, Stoneridge’s non-duty-based private-right-

of-action theory would lead to precisely the “ripple effects” that

the Court in Central Bank aimed to avoid: “newer and smaller

companies may find it difficult” to obtain securities and financial

advice and to access the U.S. capital markets, and the financial

institutions’ “increased costs . .. may be passed on to their client

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

the intended beneficiaries of the statute.”“* The additional

compliance costs and litigation expense—not to mention

liability risk—would be staggering. Every transaction for which

an allegation could be constructed that passes Stoneridge’s

proposed “purpose and effect” test** could put financial

institutions at risk for the entire amount of the issuer's fraud, as

_—

*% See Basic Inc. v. Levinson, 485 U.S. 224, 231 (1988)

(recognizing that the Court must be “careful not to set too low a standard

of materiality” because “a minimal standard might bring an

overabundance of information within its reach, and lead management

simply to bury the shareholders in an avalanche of trivial information—

a result that is hardly conducive to informed decision making”) (internal

quotations omitted).

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

N.A., 511 U.S. 164, 189 (1994).

** Br. for Petitioner at 32 (“A person engages in a deceptive act as

part of a scheme to defraud investors, and violates Section 10(b) and

Rule 10b-S(a) and/or (c), if the purpose and effect of his conduct is to

create a false appearance of material fact in furtherance of that

scheme.”).

the PSLRA’s proportionate-liability protection does not apply

to knowing violations.“ Access to U.S. capital markets would

become more expensive as investors and their companies bear

the higher transaction costs to compensate financial institutions

for soaring expenses. Foreign markets—which limit or prohibit

private class actions—would become more attractive to both

U.S. and foreign companies, depriving American investors of

bona fide investment opportunities.“ The end result: securities

class-action litigation, which is already cited as a key deterrent

to foreign issuers considering entry into U.S. markets,“ would

continue to sabotage the competitive footing of U.S. capital

markets.

These consequences are not a matter of idle speculation.

Securities-plaintiffs’ lawyers have concocted numerous costly

litigation theories post-Central Bank— including against SIFMA

and FIA members—giving rise to the conflicting circuit rulings

that precipitated this appeal.*? And foreign commentators are

“© See 15 U.S.C. § 78u-4(f)(2){A) (2007).

“7 See H.R. Rep. No. 104-50, at 20 (1995) (“Fear of [securities]

litigation keeps companies out of the capital markets.”).

* Interim Report of the Committee on Capital Markets Regulation

at 11 (2006), available at http://www.capmktsreg.org/pdfs/11.30

Committee_Interim_ReportREV2.pdf (“Foreign companies commonly

cite the U.S. class action enforcement system as the most important

reason why they do not want to list in the U.S. market.”).

* Compare, e.g., Simpson v. AOL Time Warner Inc., 452 F.3d

1040, 1048 (9th Cir. 2006) (holding that primary_liability arises. from.

“conduct that had the principal purpose and effect of creating a false

appearance of fact in furtherance of the scheme”): and In re Parmalat

Sec. Litig., 376 F. Supp. 2d 472, 504 (S.D.N.Y. 2005) (sustaining claims

for primary Section 10(b) violations where complaint alleged that secondary

actors had “used or employed a[] device or contrivance with the capacity

or tendency to deceive”); with Regents of the Univ. of Cal. v. Credit Suisse

First Boston (USA), Inc., 482 F.3d 372, 384 (Sth Cir. 2007) (holding that

“ ‘deception’ within the meaimg of § 10(b) requires that a defendant

(Cont'd)

already watching this case closely for fear that Stoneridge’s

scheme-liability theory, if endorsed, would impose new barriers

to foreign trade and investment, and damage transatlantic

economic relations.”

These adverse consequences greatly outweigh any

de minimis benefit that an expanded securities-fraud class-action

regime might provide. While federal law authorizes appropriate

securities-fraud actions, all securities class actions merely pit

one group of shareholders against another—the innocent

shareholders who happen to own the company when the suit is

brought.*' Indeed, many shareholders—particularly the

institutional investors likely to serve as lead plaintiffs—are often

on both sides and essentially end up paying themselves (minus

substantial attorneys’ fees).”

Expanding private class actions through Stoneridge’s non-

duty theory would only increase the likelihood of this circular

wealth transfer because the issuer’s and the secondary actors’

respective shareholders often overlap. Common lead plaintiffs

like pension funds and other diversified institutional investors

typically own large stakes in the financial-services companies

(Cont'd)

fail to satisfy a duty to disclose material information to a plaintiff’ and

rejecting plaintiffs’ theory that “[m]erely pleading that defendants failed

to fulfill that duty by means of a scheme or an act” constitutes § 10(b)

deception); and In re Dynegy, Inc. Sec. Litig., 339 F. Supp. 2d 804, 916

(S.D. Tex. 2004) (dismissing claims against secondary actor for

“structuring, funding, and executing” transactions that issuer falsely

reported because “plaintiffs cannot invoke subsections (a) and (c) of

Rule 10b-5 to circumvent Central Bank’s limitations on liability for a

secondary actor’s involvement in the preparation of false and misleading

statements”).

*® See generally Br. of Org. for Int’) Inv. et al. as Amici Curiae in

Support of Respondents.

‘| See Interim Report of the Committee on Capital Markets

Regulation, supra note 48, at 11.

2 See id.

that the non-duty theory would most likely affect. For example,

the New York State Common Retirement Fund owns more than

$2.5 billion of stock in Bank of America, Citigroup, and

JPMorgan Chase & Co.” Even individual investors with

moderately diversified portfolios or mutual-fund ownership

would be on both sides in a multi-defendant scheme-liability

action. For this reason, a commentator on which the Stoneridge

amici rely concludes that “[f]rom a compensatory perspective

... the securities class action performs poorly.”

Treasury Secretary Paulson has crystallized the relevant

policy concerns: “Our markets are, indeed, the best in the world.

Yet we must be vigilant, and we must do everything we can to

ensure they stay that way. . . . [T]he fundamental question we

must ask is: Have we struck the right balance between investor

protection and market competitiveness . . . ?”* A non-duty

scheme-liability regime advances neither.

D. In contrast to the clear standard that the duty

requirement provides, Stoneridge’s proposed

“nurpose and effect” test would create uncertainty

and roll back Congress’s consistent post-Central

Bank efforts to limit private securities class actions.

The Court in Central Bank emphasized the need for

certainty and predictability in Section 10(b) litigation, which,

3 See N.Y. State Common Ret. Fund Asset Listing as of March

31, 2006, at 8, 14 & 30, available at http://www.osc.state.ny.us/retire/

word_and_pdf_documents/publications/cafr/asset listings 06.pdf.

4 John C. Coffee, Jr., Reforming the Securities Class Action: an

Essay on Deterrence and Its Implementation, 106 Colum. L. Rev. 1534,

1545 (2006).

** Opening Remarks by Treasury Secretary Henry M. Paulson, Jr.

at Treasury’s Capital Markets Competitiveness Conference (Mar. 13,

2007), http://www.ustreas.gov/press/releases/hp306.htm.

% See Cent. Bank of Denver, N.A. v. First Interstate Bank of

Denver, N.A., 511 U.S. 164, 188 (1994) (quoting Pinter v. Dahl, 486

U.S. 622, 652 (1988)).

as the Court has long recognized, “presents a danger of

vexatiousness different in degree and in kind from that which

accompanies litigation in general.” *’ Without clear standards,

decisions are “ ‘made on an ad hoc basis, offering little predictive

value’ to those who provide services to participants in the

securities business.” * This uncertainty only increases the

in terrorem effect inherent in securities-fraud class actions that

lends them “a settlement value to the plaintiff out of any

proportion to its chance of success at trial.”*’ By adhering to

the duty to disclose as a prerequisite to Rule 10b-S(a) and (c)

liability, this Court would maintain the clear standard that

curtails such abuse.

A looser standard—such as Stoneridge’s proposed “purpose

and effect” test ©°—would ensnare legitimate business conduct

in private securities-fraud class-action litigation. Financial

institutions design structured-finance transactions, for example,

to confer legitimate legal, tax, or accounting benefits, but the

complex and dynamic governing rules make such transactions

particularly susceptible to securities class-action abuse.*' Indeed,

such abusive litigation has already gained traction in lower courts

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

(1975); see also Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct.

2499, 2504 (2007) (“Private securities fraud actions, however, if not

adequately contained, can be employed abusively to impose substantial

costs on companies and individuals whose conduct conforms to the

law.”).

8 Cent. Bank, 511 U.S. at 188 (quoting Pinter, 486 U.S. at 652);

see also Blue Chip Stamps, 421 U.S. at 755 (“We do not believe that

such a shifting and highly fact-oriented disposition of the issue of who

may bring a damages claim for violation of Rule 10b-5 is a satisfactory

basis for a rule of liability imposed on the conduct of business

transactions.”).

* Blue Chip Stamps, 421 U.S. at 740.

6! See generally Br. of the Am. Bankers Ass’n ef al. as Amici

Curiae in Support of Respondents at 17-20.

that nave applied vague standards similar to what Stoneridge is

proposing here.® As one district court explained, even though

the transactions depicted in the complaint may well have been

legitimate, the court was bound at the pleadings stage to sustain

securities-fraud claims against the financial-institution

defendant.’

Even under the newly strengthened scienter pleading

standard that the Court announced in Tellabs, Inc. v. Makor

Issues & Rights, Ltd.,“ Stoneridge’s nebulous “purpose and

effect” test would nevertheless reward plaintiffs for cherry-

picking disadvantageous facts—which cannot necessarily be

countered on a motion to dismiss—and ignoring legitimate

business justifications. The likely outcome would be to penalize

legitimate capital-raising behavior by adding the unnecessary

litigation costs and coercive settlement payments that the Court

has co -

® See supra note 49 and accompanying text.

* In re Parmalat Sec. Litig., 376 F. Supp. 2d 472, 504 n.160

(S.D.N.Y. 2005). The court observed:

[I]t is possible that Parmalat never sold bad invoices to

Citigroup but simply misrepresented the effect of the

securitization transactions on its financial health. On this

view, the relevant allegations likely would fail to state a

claim against Citigroup [because] Citibank would not have

committed a deceptive act but rather merely facilitated

Parmalat’s misstatements. At this stage, however, the Court

is obliged to draw from the complaint all reasonable

interences in the plaintiffs’ favor and therefore assumes

for present purposes that Citigroup securitized worthless

invoices.

Id.

* 127 S. Ct. 2499, 2513 (2007) (“A plaintiff alleging fraud in a

§ 10(b) action, we hold today, must plead facts rendering an inference

of scienter at least as likely as any plausible opposing inference.”).

% See Cent. Bank, 511 U.S. at 189 (“Because of the uncertainty

of the governing rules, [defendants] may find it prudent and necessary,

as a business judgment, to abandon substantial defenses and to pay

settlements in order to avoid the expense and risk of going to trial.”).

Stoneridge’s relaxed “purpose and effect” test would thus

roll back Congress’s efforts to contain frivolous private

securities-fraud litigation at the pleadings stage. Congress has

noted the importance of a rigorous standard to prevent strike-

suit plaintiffs from leveraging the burden and expense of

Congress has legislated repeatedly over the past twelve , :ars to

restrict private securities class-action litigation. In 1s95—the

year after Central Bank—Congress enacted the PSLRA to rein

in the rampant securities class actions that were “being used to

injure ‘the entire U.S. economy.’ ”* Consistent with that

approach, Congress chose not to expand Section 10(b)’s private

right of action to include aiding-and-abetting or conspiracy

liability, even though it extended the SEC’s enforcement

authority to exactly that conduct.® Similarly in 1998, Congress

enacted SLUSA to stop private plaintiffs from circumventing

the PSLRA by filing the same frivolous securities lawsuits in

state court.” And even after the highly publicized corporate

scandals of 2001 and 2002, Congress responded (in the

Sarbanes-Oxley Act) by legislating more stringent corporate-

governance requirements and greater SEC enforcement

® See S. Rep. No. 104-98, at 7 (1995), reprinted in 1995

U.S.C.C.A.N. 679, 686 (“If a defendant cannot win an early dismissal

of the case, ‘the economics of litigation may dictate a settlement even if

the defendant is relatively confident that it would prevail at trial.’ ”)

(quoting then-SEC Chairman Arthur Levitt); see also Cent. Bank, 511

U.S. at 189 (noting Congress’s concern over the excessive sums that

secondary actors are forced to spend “even for pretrial defense and the

negotiation of settlements”) (citing 138 Cong. Rec. $12605 (Aug. 12,

1992) (remarks of Sen. Sanford)).

® Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S.

71, 81 (2006) (quoting H.R. Rep. No. 104-369, at 31 (1995)) (discussing

PSLRA’'s legislative history and purpose).

® See 15 U.S.C. § 78t(e) (2007).

® See 15 U.S.C. § 77p(b) (2007) (preempting any “covered class

action based upon the statutory or common law of any State” that alleges

securities fraud).

authority”—and rejected the expansion of private securities-

fraud liability that Stoneridge urges here.”'

II. EXISTING FEDERAL AND STATE LAWS PROVIDE

ADEQUATE DETERRENCE AGAINST POTENTIAL

AIDERS AND ABETTORS AND AMPLE INVESTOR

PROTECTION.

PR a a oe

unwillingness to expand “scheme liability” would “create a

moral hazard encouraging fraud.”” It depicts a doomsday

scenario in which secondary actors would be emboldened to

aid and abet others’ fraud.” Stoneridge’s hyperbole is flatly

refuted by the ample deterrence of aiding and abetting, and

means for restitution, that exist from (i) numerous federal

criminal, regulatory, and civil penalties; and (ii) state-law

regulatory consequences.

” See, e.g., 15 U.S.C. § 7241(a) (2007) (requiring issuer’s

“principal executive officer or officers and principal financial officer

or officers” to certify the “effectiveness of the issuer’s internal controls’);

id. § 7262(a) (requiring issuers’ annual reports to include an “internal

control report” that states management’s responsibility “for establishing

and maintaining an adequate internal control structure and procedures

for financial reporting”); see also Sarbanes-Oxley Act of 2002, Pub. L.

No. 107-204, § 3 (2002) (conferring on the SEC the power to enforce

all provisions of the Act).

™ See 148 Cong. Rec. $6575-02, $6584 (daily ed. July 10, 2002)

(describing Senator Shelby’s proposed ameridmént to include a “private

litigation” provision that “persons that aid or abet violations . . . shall

be deemed to be in violation of such provision to the same extent as the

person to whom such assistance is provided”); see also H.R. Rep. No.

107-414, at 54 (2002) (lamenting that Congress did not “heed these

recommendations” to expand the private right of action).

” Br. for Petitioner at 35.

% Jd. (“[Cjompanies will quickly learn that they can get away

with fraud.”).

A. Federal criminal penalties are a professional death

sentence for most secondary actors, including

financial institutions.

The Justice Department’s vigorous prosecution of

securities-law violations provides a potent deterrent to aiding

and abetting fraud. Since its creation in 2002, the Corporate

Fraud Task Force has charged more than 1,300 defendants and

secured more than a thousand corporate fraud convictions,

including the convictions of a hundred CEOs or corporate

presidents.” The Department’s success is partly attributable to

its broad statutory powers to punish secondary actors who assist

others in committing securities fraud—the same targets of

Stoneridge’s suit here. That is, the United States Code

criminalizes aiding and abetting violations of the securities laws

and mail and wire fraud,” as well as conspiracy to violate those

laws.”° Prosecutors are further able to return ill-gotten gains

directly to injured shareholders through restitution and

forfeiture”—without the hefty contingency-fee payout to

plaintiffs’ lawyers.

The threat of a criminal indictment is a serious deterrent—

because even an indictment, and certainly a conviction, would

amount to a professional death sentence.” One need look no

™ See U.S. Dep’t of Justice, Fact Sheet: Corporate Fraud Task

Force (Aug. 9, 2006), available at http://www.usdoj.gov/opa/pr/2006/

August /06 odag 521.html.

> See 18 U.S.C. § 2 (2007).

%® See id. § 371.

” See id. § 3572 (restitution must be paid before fines and

penalties); id. § 981(a)(1XD) & (E) (forfeiture of proceeds from mail

and wire fraud).

See, e.g., Kurt Eichenwald, Brokerage Firm Admits Crimes in

Energy Deals, N.Y. Times, Oct. 28, 1994, at Al (“ ‘[C}riminal prosecution

of these types of {securities} firms can be the equivalent of the corporate

death penalty ....’”) (quoting former SEC Commissioner Joseph

Grundfest).

further for evidence than Arthur Andersen LLP, which was

forced to shut its doors and terminate most of its 28,000 U.S.

(and 85,000 worldwide) employees” after a conviction on just

one obstruction-of-justice count (that was ultimately reversed).

Before Arthur Andersen, Drexel Burnham Lambert—once the

nation’s fifth largest securities firm—collapsed and iaid off 5,400

employees after pleading guilty to securities charges.*' And these

existence-threatening risks are not limited to Wall Street and

corporate America; they affect any business that depends on its

reputation and the public’s trust. For example, two major

plaintiffs’ law firms have recently struggled to retain clients

following a criminal investigation and indictment ® because, as

one lead plaintiff declared, the “indictment so taint[s the firm]

that neither it nor its attorneys—even those not specifically

targeted . . . should continue to serve as class counsel.” *

” Jonathan D. Glater, Last Task at Andersen: Turning Out the

Lights, N.Y. Tes, Aug. 30, 2002, at C3.

8 See Arthur Andersen LLP v. United States, 544 U.S. 696 (2005)

(reversing obstruction-of-justice conviction).

*! See Key Events in the Prosecution, N.Y. Times, Apr. 21, 1990,

at 1; Pat Widder, Timing Helps Salomon Beat Drexel’ Fate, Cui. TRiB.,

May 24, 1992, at Cl (“Drexel paid $650 million, pleaded guilty to six

felonies and floundered; the firm was driven into bankruptcy.”).

® See, e.g., Order, In re New Motor Vehicles Can. Exp. Antitrust

Litig., 03-MDL-01532-DBH (D. Me. Dec. 18, 2006) (granting motion

to remove Milberg Weiss from leadership position in multi-district

litigation because of criminal indictment’s taint); Order, Jn re Medtronic,

Inc. Implantable Defibrillator Prod. Liab. Litig., 0S-MDL-1726-JMB-

AJB (D. Minn. June 5, 2006) (ordering sua sponte the removal of Milberg

Weiss from the Plaintiffs’ Steering Committee—even though there were

no allegations that the attorney handling case had violated any laws—

because of firm’s criminal indictment); Order, Archdiocese of Milwaukee

Supporting Fund, Inc. v. Halliburton Co., No. 02-CV-1152-M (N.D.

Tex. Feb. 28, 2007) (granting lead plaintiffs’ motion to replace Lerach

as lead counsel).

® Reply Br. of Lead Pl. in Support of Mot. for Substitution of

Lead Counsel at 7, Archdiocese of Milwaukee Supporting Fund, Inc. v.

Halliburton Co., No. 02-CV-1152-M (N.D. Tex. Dec. 27, 2006).

Even when corporate defendants are able to avoid criminal

prosecution by cooperating with the government, they still face

stiff financial penalties and reputational damage. For example,

CIBC was forced to exit entirely the U.S. structured-finance

business—a legitimate and profitable field for financial

institutions—as part of its deferred-prosecution agreement

arising from Enron. In a similar agreement relating to its tax-

shelter practice, the accounting firm KPMG agreed to pay a

$456 million penalty and abandon three of its businesses to avoid

criminal charges that KPMG “knew . . . would probably kill

it 99 85

And on facts similar to Stoneridge, AOL/Time Warner

agreed to pay $210 million in investor restitution and penalties

to resolve charges of aiding and abetting PurchasePro’s revenue

misstatements. The criminal complaint had charged AOL with

entering sham transactions (in which AOL received $70 million

plus stock warrants) that its counterparty, PurchasePro, later

used to report inflated revenue. Illustrating the pressure that

»rosecutors can exert, the $210 million that AOL paid to resolve

the criminal charges was greater than the benefit it received

from the challenged transaction. ;

This case itself illustrates that the government can and will

punish vendor conduct that aids and abets an issuer’s fraud on

the market. As Stoneridge notes,” four Charter officers were

* Press Release, U.S. Dep’t of Justice, Canadian Imperial Bank

of Commerce Agrees to Cooperate with Enron Investigation (Dec. 22,

2003), available at http://www.usdoj.gov/opa/pr/2003/Decembe:/

03_crm_718.htm.

* David Reilly, Narrow Escape: How a Chastened KPMG Got

by Tax-Shelter Crisis — Boss of Just Three Days Admitted Firm’ Sins,

Fought to Keep Clients, Wat St. J., Feb. 15, 2007, at Al.

% See Press Release, U.S. Dep’t of Justice, America Online

Charged with Aiding and Abetting Securities Fraud (Dec. 15, 2004),

available at http://www.fbi.gov/dojpressrel/pressrel04/aolrelease

121504.htm.

8’ Br. for Petitioner at 37.

indicted for their roles in the alleged transactions on 14 counts

of mail fraud," wire fraud,” conspiracy to commit mail and

wire fraud,” and aiding and abetting mail and wire fraud.°' The

charges led to guilty pleas, a combined 26 months of prison

time, and $775,000 in personal fines.”

B. The SEC has responded to Congress’s decision to

expand its—and not private plaintiffs’—

enforcement and recovery powers.

The SEC’s broad powers and lengthy record of pursuing

wrongdoers and returning funds to investors further belie the

Stoneridge amici’s argument that the government is “ill-

equipped” to enforce the securities laws on a large scale.”

Indeed, Congress thought just the opposite when it expanded

the SEC’s mandate in 1995 to include bringing suits against

secondary actors for aiding and abetting securities violations.™

And by passing the Sarbanes-Oxley Act’s FAIR Funds provision,

Congress once again rejected a proposal to overrule Central

Bank by expanding private litigation to include aiding and

abetting,” instead favoring greater SEC enforcement authority.

It directed the SEC to create a fund to collect and return to

injured investors monies that the SEC recovers through

disgorgement and civil penalties.”

% See 18 U.S.C. § 1341 (2007).

® See id. § 1343.

® See id. § 371.

" See id. § 2.

% Judgment, United States v. Barford, No. 4:03CR00434

(E.D. Mo. Apr. 22, 2005); Judgment, United States v. Kalkwarf,

No. 4:03CR434 (E.D. Mo. Apr. 22, 2005); Judgment, United States v.

McCall, No. 4:03CR434 (E.D. Mo. Apr. 22, 2005); Judgment, United

States v. Smith, No. 4:03CR434 (E.D. Mo. Apr. 22, 2005).

% See Br. of the N. Am. Sec. Adm’rs Ass’n, Inc. as Amicus Curiae

in Support of Petitioner at 19.

™ See 15 U.S.C. § 78t(e) (2007).

% See supra note 71 and accompanying text.

% See 15 U.S.C. § 7246 (2007).

The FAIR Funds provision’s sponsors sought to compensate

investors without incurring the high legal fees associated with

private class-action litigation and to ensure that “[t]his money

is [used] for investors’ retirement accounts, not oceanfront

estates for ambulance-chasing trial lawyers.”®’ The statute is

thus designed to recapture “[n]inety percent or more of forfeited

ill-gotten gains . . . [for] injured investors”“*—a huge benefit

considering that legal fees can account for a substantial portion

of any private recovery, even when institutional or state plaintiffs

have the leverage to “ ‘drive a hard[] bargain’ with law firms.””

In Ohio’s securities class-action settlement with AOL, for

example, $31 million of the $175 million settlement went to

pay the plaintiffs’ lawyers’ fees and expenses.'”

The SEC has embraced its increased authority. From 2002

to 2006, it collected more than $8 billion for distribution to

investors through the FAIR Funds program.'®' And just as the

Justice Department has used its criminal powers against vendors

who aid and abet an issuer’s fraud on the market, the SEC has

similarly used its enforcement authority. In fact, it has already

obtained large recoveries from Scientific-Atlanta and Motorola

for their alleged aiding and abetting." The SEC has (i) sued

%” See Press Release, Office of Rep. Richard H. Baker, U.S. House

of Representatives, Returning Funds to Defrauded Investors (Jul. 17,

2002) (announcing proposed FAIR Funds provision to the Sarbanes-

Oxley Act) (quoting Rep. Michael G Oxley); see also id. (“Unless we

act on behalf of investors, this money merely will be transferred from

greedy corporate executives to greedy trial lawyers.”) (quoting Rep.

Michael G. Oxley).

% See id.

® Peter Krouse, Ohio Gains $144 Million for Pensions in

Settlement, CLEVELAND PLAIN DEALER, Mar. 8, 2007, at Al.

'! See SEC, 2006 Performance and Accountability Report at 23

(2006), available at http://www.sec.gov/about/secpar2006.shtml.

12 See Br. for Petitioner at 37.

Scientific-Atlanta for entering transactions with another cable

company that were nearly identical to those it entered with

Charter; (ii) recovered $20 million in disgorgement through a

settlement with Scientific-Atlanta;'” and (iii) recovered $25

million in civil penalties from Motorola for the same conduct.'“

Not only can the SEC sue secondary actors as aiders and

abettors under Section 20(e),'® it can also sue them for violating

Section 13 (as it did Scientific-Atlanta),'° which addresses the

accuracy of corporate books and records. Rule 13b2-2(b)(1),'”’

which the SEC adopted to enforce Section 303(a) of the

Sarbanes-Oxley Act,'® applies primary liability to customers,

vendors, creditors, accountants, attorneys, securities

professionals, or other advisors who, under the direction or

request of an issuer’s officers or directors, (i) provide false or

misleading information to auditors, (ii) enter into “side

agreements” that enable issuers to mislead auditors, or (iii) place

pressure on auditors that compromises the audit report’s

integrity." Accordingly, if a secondary actor provides false

1 See SEC v. Scientific-Atlanta, Inc., SEC Litig. Release No.

19735 (Jun. 22, 2006), available at http://www.sec.gov/litigation/

litreleases/2006/Ir19735.htm.

'% See In re Motorola, Inc., SEC Exchange Act Release No. 55,725

(May 8, 2007), available at http://www.sec.gov/litigation/admin /2007/

34-55725.pdf.

10S See 15 U.S.C. § 78t(e) (2007).

06 See id. § 78m(b) (2007); see also supra note 103 and

accompanying text.

'? See 17 C.F.R. § 240.13b2-2(b){1) (2007) (“No officer or

director of an issuer, or any other person acting under the direction

thereof, shall directly or indirectly take any action to coerce, manipulate,

mislead, or fraudulently influence any independent public or certified

public accountant engaged in the performance of an audit or review of

the financial statements . . . .”).

8 15 U.S.C. § 7242(a) & (b) (2007).

9 Improper Influence on Conduct of Audits, Exchange Act

Release No. 3447890, Investment Company Act Release No. 26,050,

68 Fed. Reg. 31820, 31821--22 (2003).

documents to an issuer’s auditor—even without uttering a word

publicly—the SEC also could sue it as a primary Rule 13b2-

2(b)(1) violator.

In addition to the SEC’s enforcement power, it also oversees

self-regulatory organizations, such as the Financial Industry

Regulatory Authority," which can bring disciplinary actions

against securities firms and their employees who aid and abet

another’s Section 10(b) violation.'"'

C. State penalties and recovery methods broadly

encompass aiding and aoetting securities-law

violations.

Besides the formidable deterrence the DOJ, SEC, and SROs

provide, a broad array of state-law penalties also deters

secondary actors from aiding securities violations. These include

state “blue sky” laws that permit attorneys general and state

regulators to seek fines and obtain restitution from,'” and impose

''0 The Financial Industry Regulatory Authority (“FINRA”) is the

nongovernmental regulatory body created in 2007 by the consolidation

of the National Association of Securities Dealers, Inc. and the New

York Stock Exchange’s regulation, enforcement, and arbitration

functions. FINRA currently regulates all securities firms doing business

in the United States.

'! See Dept of Enforcement v. Perles, CA F980005, 2000 NASD

Discip. LEXIS 9, at *20—24 (Aug. 16, 2000) (holding that Central Bank

does not apply to NASD’s interpretation of its own Conduct Rules and

that aiding and abetting another’s securities fraud violates NASD

Conduct Rule 2110), aff'd in relevant part, Exchange Act Release No.

45691, 2002 SEC LEXIS 847 (Apr. 4, 2002); see also, e.g., Dept of

Enforcement v. J. Alexander Sec., Inc., CA F010021, 2004 NASD Discip.

LEXIS 16, at *45-46, 65-69 (Aug. 16, 2004) (holding that aiding and

abetting another’s securities fraud violates NASD Conduct Rule 2110,

and barring aider and abettor from associating with any NASD firm).

"2 See, e.g., Del. Code Ann. tit. 6, § 7325 (2007) (permitting the

commissioner to fine and order restitution form any person “who aids

and abets any person who wilfully violates any provision of [the

(Cont'd)

criminal sanctions against,' anyone who aids state securities-

law violations. For example, in recent years, the New York

attorney general has successfully used New York’s Martin Act

to recover more than $5 billion in securities-fraud settlements. ''*

And state attorneys general have actively pursued aiders and

abettors.''°

(Cont'd)

Delaware Securities Act]”); Cal. Corp. Code §§ 25403(b), 25530-25536

(2007) (permitting the commissioner to take action against any person

who knowingly provides substantial assistance to another’s violation

of California’s securities laws); State v. McLeod, 12 Misc. 3d 1157(A),

2006 WL 1374014, at *11 (N.Y. Sup. Ct. 2006) (holding that a

defendant’s mere participation in another’s stock-spinning scheme “‘is

sufficient to subject [that defendant] to the Martin Act’s reach”) (citing

N.Y. Gen. Bus. Law, Art. 23-A §§ 352(1) & 352-c(2)).

3 See, e.g., N.Y. Gen. Bus. Law, Art. 23-A §§ 352-c(4)+(6), 352-

d, 358 (authorizing criminal penalties and prosecution for violations of

Martin Act’s anti-fraud provisions); Del. Code Ann. tit. 6, § 7325 (2007)

(authorizing criminal prosecution of any person who willfully aids and

abets a violation of securities laws); Cal. Corp. Code §§ 25540-25542

(same); 815 Ill. Comp. Stat. § 5/14 (same).

'4 Paul Davies, Spitzer's Successor May Not Follow in His

Footsteps—Cuomo Targets Medicaid Fraud, Guns, Government

Corruption; Grasso Case Will Be Early Test, Wa.t St. J., Nov. 11, 2006,

at Bl.

''S See, e.g., Press Release, N.Y. State Att’y Gen., Former Trust

Company Officials Arrested in Late Trading Fraud (Nov. 25, 2003) (an-

nouncing that the combined efforts of the New York Attorney General,

SEC, and Office of the Comptroller of Currency had resulted.in felony -

‘charges against three of Security Trust Co.’s executives for assisting in

mutual-fund late trading and had led to the firm’s dissolution), available

at http://www.oag.state.ny.us/ press/2003/nov/nov25a_03.html; SEC v.

J.P. Morgan Chase & Co., SEC Litig. Release No. 18252 (Jul. 28, 2003)

(announcing civil complaint and $135 million settlement achieved “in

coordination with the New York County District Attorney’s Office”

arising from bank’s aiding and abetting accounting fraud), available at

http://www.sec.gov/litigation/litreleases/Ir18252.htm; SEC v. Southmark

(Cont'd)

CONCLUSION

The essence of securities fraud is making material

misstatements or failing to disclose despite a duty to do so.

That is fair game for private securities-fraud liability. The

securities laws do not, however, allow private plaintiffs to sue

third parties that owed them no duties and indeed may never

have deceived them at all. Yet that is precisely what Stoneridge’s

scheme-liability theory would accomplish. For financial

institutions that collectively do business with virtually every

company seeking to access the U.S. capital markets, the

consequences of applying Stoneridge’s radical liability theory

would be especially costly. Added litigation and compliance

costs would further weigh down the U.S. capital markets in the

global race to lure companies and investors. And this handicap

would yield no corresponding benefits, considering the litany

of other fraud deterrents and investor remedies. In the end, the

only clear winners would be plaintiffs’ lawyers, who would have

won the right to sue additional parties for the issuer’s fraud, all

in pursuit of deep pockets to pay higher fees. Congress has

repeatedly refused to give the lawyers that windfall, and this

Court should decline that same invitation. The Court of Appeals’

judgment should be affirmed.

(Cont'd)

Advisory, Inc., SEC Litig. Release No. 17818 (Oct. 30, 2002)

(acknowledging Oklahoma Department of Securities’ assistance in

bringing civil aiding-and-abetting action), available at http://

www.sec.gov/litigation/litreleases/Ir17818.htm; SEC v. Christian, SEC

Litig. Release No. 19294 (Jul. 7, 2005) (acknowledging New York

Attorney General’s assistance in bringing civil enforcement action

relating to market timing of mutual-fund trades, including for aiding

and abetting Section 10(b) violations), available at http://www.sec.gov/

litigation/litreleases/Ir19294.htm.

Respectfully submitted,

IRA D. HAMMERMAN

Kevin M. CarROLL

SECURITIES INDUSTRY AND

FINANCIAL MARKETS ASSOCIATION

1399 New York Avenue, NW

Washington, DC 20006

BARBARA B. WIERZYNSKI

FUTURES INDUSTRY ASSOCIATION

2001 Pennsylvania Avenue, NW

Suite 600

Washington, DC 20006

WALTER DELLINGER

Counsel of Record

O”’ ME Lveny & Myers LLP

1625 Eye Street, NW

Washington, DC 20006

(202) 383-5300

JONATHAN ROSENBERG

WILLIAM J. SUSHON

B. ANDREW BEDNARK

O’MELveny & Myers LLP

7 Times Square

New York, NY 10036

Counsel for Amici Curiae The Securities Industry and Financial

Markets Association and Futures Industry Association

August 15, 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.