Government wants securities liability limited
on Aug 15, 2007 at 3:47 pm
UPDATED 8/15, 10:20 PM: Added both sides’ merits briefs (at bottom of post, after jump).
Switching sides in a major fight over securities law, the Bush Administration on Wednesday told the Supreme Court that the government generally opposes liability for third parties in fraud lawsuits if there is no proof that they directly deceived investors who were counting on them for solid information. The liability issue involves entities such as investment bankers who act as business partners to a firm that directly engages in deception or manipulation of securities. The brief by U.S. Solicitor General Paul D. Clement can be downloaded here. The government thus abandoned a substantial part of a position it had held in prior cases in support of investors; the brief also contradicted the majority of the present members of the Securities and Exchange Commission, and the chairmen of leading financial and other committees in Congress. Clement resisted a strenuous lobbying effort by lawmakers to stay on the sidelines if he could not suppot investors.
The brief that finally emerged from weeks of maneuvering and lobbying had some of the characteristics of a compromise, but ultimately employed language that suggested that third-party liability should be difficult to prove, absent clear evidence of reliance by investors on any misconduct by such other parties.
Filed in Stoneridge Investment v. Scientific-Atlanta (06-43), a case scheduled for oral argument on Oct. 9 in the new Term, the brief urged the Court to uphold a ruling by the Eighth Circuit Court that broadly insulated third parties from liability for securities deception or manipulation. Clement, however, argued that the Eighth Circuit had gone too far in its curb on third party liability. The decision nevertheless should be upheld, the Solicitor General argued, because there was no proof that any deception in the Stoneridge case by third parties was relied upon by investors. The Circuit Court was wrong, the brief said, in concluding that a third party that had some role in a deceptive scheme can never be held liable for someone else’s fraud if the third party did not make a misstatement or an omission that it had a duty to disclose or did not direclty engage in manipulating trading. Deception can occur by means short of that, the brief said.
The dispute turns, at least in part, on the meaning of a 1994 Supreme Court ruling, in Central Bank v. First Interstate Bank; there, the Court barred private securities fraud claims based on assertions of aiding and abetting fraud by others. Making third parties liable for a role in someone else’s fraud, absent proof that investors relied on third party conduct, the Solicitor General contended, would be “the functional equivalent” of aider-abbettor liability in suits filed by private investors.
Seeking to build on the 1994 precedent, Clement’s new brief argued that “it would greatly expand the inferred private right of action under Section 10(b) and Rule 10b-5 if ‘secondary actors’ could be held primarily liable whenever they engage in allegedly deceptive conduct, even if investors do not rely on (and are not even aware of) that conduct. Such a rule would expose not only accountants and lawyers who advise issuers of securities, but also vendors (such as respondents) and other firms that simply do business with issuers, to potentially billions of dollars in liability when those issuers make misrepresentations to the market. Such a rule would thereby considerably widen the pool of deep-pocketed defendants that could be sued for the misrepresentations of issuers, increasing the likelihood that the private right of action will be ’employed abusively to impose substantial costs on companies and indviiduals whose conduct confirms to the law.’ ”
Although Clement refused to put the current SEC majority’s opposing view before the Court, as the commissioners had asked him to do, their views have been offered to the Court in filings by members of Congress, who have asked permission to join in the Stoneridge case.
The filing of the brief ended weeks of public and private dispute over what role, if any, the government would be playing in the Stoneridge case, and in another case, raising the same issue, that the Supreme Court has yet to act upon — the case of California Regents v. Merrill Lynch, et al. (docket 06-1341), which involves billions of dollars in potential liabilty for major investment banking houses in a part of the Enron scandal. The Fifth Circuit, like the Eighth, rejected “scheme liability” for third parties. Clement had declined in June when asked by the SEC to file a brief supporting Stoneridge. Since then, the lingering question was whether the government would stay out of the case entirely, or side with third parties — as President Bush and Treasury Secretary Henry Paulson have been pressing Clement to do.
Clement’s brief made a slight bow to the value of investor lawsuits, saying that “meritorious private actions are an essential supplement to criminal prosecutions and civil enforcement actions brought by the government.”
But, he went on, “private securties actions can be abused in ways that impose substantial costs on companies that have fully complied with the applicable laws. The United States…has responsibility, through…the federal banking agencies, for ensuring that entities providing services to publicly traded companies are not subject to inappropriate secondary liability.”
The brief’s challenge to the scope of the Eighth Circuit ruling against “scheme liability” focused on the lower court’s exclusion of broad categories of third-party conduct from securities fraud liability. The Solicitor General went so far as to say that, since the Circuit Court was wrong about that, it may well be true that the third parties in the Stoneridge case actually did enage in deception in violation of the law against securities manipulation. If a third party itself engages in deceptive conduct, that could lead to liability.
“Contrary to the view seemingly expressed by the court of appeals,” the brief argued, “Section 10(b)’s prohibition against deception is not limited to actual misstatements or omissions, but encompasses non-verbal deceptive conduct as well.”
The Solicitor General went on, however, to say that investors claiming a third party shared in “scheme liability” should have to show, in addition to deception, that investors or others had actually relied upon the third parties’ acts of deception. In the Stoneridge case, Clement said, the investors do not allege that they were even aware of the transactions that the third parties engaged in along with the alleged primary violator.
He added: “Allowing liability for a primary violation under the circumstances presented here would constitute a sweeping expansion of the judicially inferred private right of action in Section 10(b) and Rule 10b-5…”
Additionally, the bottom-side merits brief, filed today, can be found here. The petitioner’s brief, filed in June, can be found here.
