By James Hamilton, J.D., LL.M.
Secondary actors, such as investment banks and accountants, who act in concert with public companies in schemes to defraud investors cannot be held liable as primary violators of Rule 10b-5 unless they directly make public misrepresentations; owe the shareholders a duty to disclose; or directly manipulate the market for the company’s securities through practices such as wash sales or matched orders. This was the ruling of a Fifth Circuit panel in an action alleging that investment banks engaged in transactions that allowed Enron to misstate its financial condition. (Regents of the University of California v. Credit Suisse First Boston, 06-20856, March 19, 2007).
At most, said the appeals court, the banks could have aided and abetted Enron’s deceit by making its misrepresentations more plausible but their conduct did not rise to primary liability under Rule 10b-5. And, under the Supreme Court’s Central Bank ruling, there is no private action for secondary aiding and abetting liability under Rule 10b-5. The investment banks owed no duty to Enron’s shareholders, emphasized the panel.
While acknowledging that the investment banks do escape liability for alleged conduct that was ``hardly praiseworthy,’’ the appeals court reasoned that Congress was not irrational to promote plain legal standards for actors in the financial markets by limiting secondary liability. In the antifraud statute, Congress is balancing competing desires to provide some remedy for securities fraud without opening the floodgates for nearly unlimited and frequently unpredictable liability for secondary actors in the securities markets. And, in Central Bank, the Supreme Court was seeking certainty through strict construction of § 10(b) against inputting aiding and abetting liability for secondary actors under the rubric of deceptive acts or schemes.
The district court held that the presumption of reliance applied because the facts indicated
that the banks had failed in their duty not to engage in a fraudulent ‘scheme. The court determined that a deceptive act within the meaning of Rule 10b-5(c) includes
participating in a transaction whose principal purpose and effect is to create a false appearance of revenues.
The appeals court addressed only the definition of deceptive act, because it was dispositive of the appeal, and not the district court’s scheme liability holding.
The appeals court held that the district court’s conception of deceptive act liability is inconsistent with the Supreme Court’s decision that § 10 does not give rise to aiding and abetting liability. An act cannot be deceptive within the meaning of § 10(b) where the actor has no duty to disclose. Presuming the allegations to be true, Enron committed fraud by misstating its accounts, but the banks only aided an abetted that fraud by engaging in transactions to make it more plausible. The investment banks owed no duty to Enron’s shareholders, said the appeals court.
In order to be true to the Supreme Court’s concerns when it ruled that section 10(b) does not give rise to aiding and abetting liability, noted the appeals panel, it is essential to ensure that lower courts do not misapply aiding-and-abetting liability under the guise of primary liability through an overly broad definition of deceptive acts.
In a concurring opinion, Judge Dennis said that the Fifth Circuit has now aligned itself with the Eighth Circuit and immunizes a broad array of undeniably fraudulent conduct from civil liability under Rule 10b-5, effectively giving secondary actors license to scheme with impunity, as long as they keep quiet. He described the majority’s interpretation of the statutory language of section 10(b) as ``cramped.’’ He concluded that the district court erred by construing too broadly the joint and several liability provision of the Private Securities Litigation Reform Act of 1995.