Academic journal article Duke Law Journal

Freedom to Defraud: Stoneridge, Primary Liability, and the Need to Properly Define Section 10(B)

Academic journal article Duke Law Journal

Freedom to Defraud: Stoneridge, Primary Liability, and the Need to Properly Define Section 10(B)

Article excerpt

ABSTRACT

In Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., the Supreme Court determined that primary liability under section 10(b) of the Securities Exchange Act does not extend to third-party actors engaged in sham transactions, even when such transactions have the purpose and effect of deceiving investors. The Court reasoned that there is no liability when an actor's deceptive conduct is not communicated directly to investors. This Note argues that the Supreme Court misinterpreted section 10(b) and Rule 10b-5 and that policy considerations weigh in favor of using securities fraud litigation to deter culpable actors. It argues both for the substantial participation standard and the revitalization of scheme liability in order to best comply with the language and policies of section 10(b) and Rule 10b-5.

INTRODUCTION

"Because the text of [section] 10(b) does not prohibit aiding and abetting, we hold that a private plaintiff may not maintain an aiding and abetting suit under [section] 10(b)." (1) In 1994, the Supreme Court declared that only primary violators--not aiders and abettors--could be held liable for federal securities fraud under the Securities Exchange Act of 1934. (2) Subsequently, lower courts struggled to reach a consensus regarding who qualifies as a primary violator. Adding to the confusion was another wrinkle: scheme liability emerged to increase the potential liability for third parties. In Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., (3) the Supreme Court attempted to answer many of these questions when it held that liability is inappropriate even if an actor "engaged in conduct with the purpose and effect of creating a false appearance of material fact to further a scheme to [deceive investors]." (4)

This Note addresses the debate over primary liability under section 10(b) and Rule 10b-5 in the context of private securities class actions. Unsurprisingly, the arguments surrounding Central Bank of Denver v. First Interstate Bank of Denver, (5) and its subsequent effect, are well documented. (6) Therefore, this Note does not weigh in on the issues specific to aiding and abetting liability. Instead, it focuses on the limits of primary liability in securities fraud with an emphasis on the developments surrounding scheme liability.

Among traditional approaches to primary liability, the substantial participation approach is more appropriate than the bright-line approach because it better advances the policy objective of deterring culpable actors. The Supreme Court should have used scheme liability to achieve deterrence in Stoneridge, especially because many circuits refuse to move from the bright-line to the substantial participation approach. Important to both of these arguments is the recognition that both scheme liability and substantial participation are completely consistent with the Supreme Court's decision in Central Bank. Part I discusses the development of liability under section 10(b) and Rule 10b-5, culminating in an examination of the traditional approaches to primary liability. It argues that under the language of the statute, the substantial participation approach is appropriate. Part II introduces the issues surrounding scheme liability. It addresses the Stoneridge decision and argues that the Court's reasoning in that case is flawed. Part III examines the possible policy objectives underlying section 10(b) liability, concluding that such liability should be imposed with a focus on deterring culpable actors. It then utilizes the deterrence objective and offers suggestions for courts to reach culpable conduct while critically examining the approaches to primary and scheme liability.

I. DEVELOPMENT OF SECTION 10(B) AND RULE 10B-5 LIABILITY

A. Aiding and Abetting Pre-Central Bank

Section 10(b) of the Securities Exchange Act of 1934 prohibits any person from directly or indirectly using or employing "in connection with the purchase or sale of any security . …

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