Former SEC Chairs Pitt and Hills Urge Supreme Court to Reject Scheme Liability

Former SEC Chairs Harvey Pitt, Rod Hills, and Harold Williams, along with a plethora of former Commissioners, have filed a brief urging the Supreme Court to reject scheme liability for non-speaking secondary actors in private securities fraud actions. The former SEC officials call scheme liability a semantic ploy designed to recast secondary conduct as a primary violation of Rule 10b-5 in order to get around the Court’s ruling in the Central Bank case that there is no private right of action against secondary actors who aid and abet securities fraud.

The former chairs warned that the approval of scheme liability would inject confusion into Rule 10b-5 actions since not even the proponents of scheme liability can consistently define this amorphous concept. They further contend that scheme liability exposes those engaging in commercial transactions with public companies to disproportionate damages orders of magnitude greater than the size of the transaction alleged to give rise to the liability.

Among former SEC Commissioners who joined the three chairs on the brief were Joseph Grundfest, Richard Roberts, Aulana Peters, Edward Fleischman, Stephen Friedman, Issac Hunt, and Laura Unger. Former SEC General Counsels James Doty and Simon Lorne also joined the effort.

In the case of Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. (No. 06-43), the Court is slated to determine whether non-speaking actors, such as investment banks and auditors, that knowingly commit securities fraud can be held liable for their actions. The brief addressing this question, a concept known as scheme liability, was filed in support of the defendants in the Stoneridge case.

Interpreting the 1994 Central Bank opinion, the former chairs said that scheme liability involves secondary conduct within the meaning of the Court’s opinion; and that mere knowing participation in another’s alleged fraud is not enough for liability to attach. Moreover, they maintain that Congress has sanctioned this approach since in the 1995 Private Securities Litigation Reform Act it specifically gave the SEC enforcement power against secondary actors who aid and abet securities fraud.

Since Congress expressly refrained form similarly empowering private investors, reasoned the former SEC chairs, the Court should not do by fiat what Congress declined to do by statute. The amici concluded that Central Bank and the congressional reaction to it clarify that the antifraud rule does not encompass scheme liability. More broadly, they emphasized that the implied private right of action under Rule 10b-5 is a judicial creation; and that the days of judicially implied private actions are ``long past.’’ Moreover, the Court has recognized that an expansive reading of the implied right is susceptible to abuse.