Class Action Securities Fraud Claims Against Business Partners of Internet Company Failed to Establish § 10(b) Liability for Secondary Actors
Plaintiff filed a putative class action against multiple defendants alleging securities fraud arising out of the overstating of revenues of an Internet company. Defense attorneys for several outside defendants and individual defendants successfully moved to dismiss the § 10(b) claims under the Securities Exchange Act of 1934 on the grounds that Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994) holds that § 10(b) does not permit recovery for aiding and abetting, and that the moving defendants were not “primary violators.” Simpson v. AOL Time Warner Inc., 452 F.3d 1040, 1042 (9th Cir. 2006). The Ninth Circuit disagreed with the interpretation of Central Bank proffered by the defense, but affirmed because plaintiff had not sufficiently alleged that defendants were primary violators of § 10(b). Id., at 1043. We do not here summarize the detailed fact pattern set forth in the Ninth Circuit opinion. Rather, we focus on the court’s holdings concerning Central Bank and § 10(b) liability.
Defense attorneys argued that “Central Bank limited primary liability under § 10(b) to defendants who personally made a public misstatement, violated a duty to disclose or engaged in manipulative trading activity, and not to those engaged in a broader scheme to defraud.” Simpson, at 1043. The Ninth Circuit disagreed. While the Supreme Court held that Rule 10b-5 liability “does not extend beyond the limits of § 10(b),” id., at 1046, it also cautioned “that secondary actors, other than the securities issuer, may be liable as primary violators under § 10(b) when all elements of the statute are satisfied,” id., at 1047. And while § 10(b) does not extend to the act of “merely ‘aiding and abetting’” a violation thereof, under Ninth Circuit authority one may be found to have primary liability under § 10(b) – even without making any statements – if they substantially participated or were intricately involved in preparing the fraudulent statements. Id., at 1048 (citing Howard v. Everex Sys., Inc., 228 F.3d 1057, 1061 n.5 (9th Cir. 2000).
Turning to the specific question of what constitutes primary liability under an alleged scheme to defraud, the Circuit Court held, apparently as a matter of first impression in the Ninth Circuit, that “the defendant must have engaged in conduct that had the principal purpose and effect of creating a false appearance of fact in furtherance of the scheme.” Simpson, at 1048. The Court made it clear that this holding was limited, explaining at page 1048:
It is not enough that a transaction in which a defendant was involved had a deceptive purpose and effect; the defendant’s own conduct contributing to the transaction or overall scheme must have had a deceptive purpose and effect. (Italics added.)
On the other hand, the Court refused to limit liability under § 10(b) “to only those who draft or edit the statements released to the public.” Id., at 1049. The Court’s reasoning appears sound: “Conduct by the defendant that does not have a principal legitimate business purpose, such as the invention of sham corporate entities to misrepresent the flow of income, may have a principal purpose of creating a false appearance.” Id. (citations omitted).
We do not here discuss the Circuit Court’s application of its new rule to the case before it; we note, however, that the Court explained that even though a defendant’s conduct must be considered in the context of the alleged scheme to defraud, a determination of whether a particular defendant is a “primary violator” of § 10(b) requires that the defendant’s conduct “be viewed alone for whether it had the purpose and effect of creating a false appearance of fact” in furtherance of the alleged scheme. Id., at 1050.