Securities Reform: Dodd Measure Would Restore Aiding & Abetting Liability

Last September Sen. Arlen Specter introduced S. 1551 which would overturn the Supreme Court's Stone Ridge Investments decision which barred "aiding and abetting" liability in securities fraud cases, as we reported here. Specter held hearings but as a free-standing measure it had little chance of passage.

K. Stewart Evans of Pepper Hamilton reports that [retiring] Sen. Christopher J. Dodd (D-Conn.)’s draft Restoring American Financial Stability Act of 2009 contains a provision (page 795 of 1,136) that amends Section 21D of the Securities Exchange Act of 1934 (15 U.S.C. 78u-4) to overruleStoneridge. It provides:

(g) PRIVATE CIVIL ACTIONS.—For purposes of any private civil action implied under this title, any person that knowingly or recklessly provides substantial assistance to another person in violation of this title, or of any rule or regulation issued under this title, shall be deemed to be in violation of this title to the same extent as the person to whom such assistance is provided.

Evans laments that

the proposed amendment 15 U.S.C. 78u-4 would allow plaintiffs to pursue secondary actors such as accountants, underwriters, lawyers, customers, and suppliers without having to prove they relied upon their statements or representations when purchasing or selling securities.

In an action under Sec. 10(b)(5) of the Securities and Exchange Commission Act a plaintiff must prove (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.See Dura Pharms., Inc. v. Broudo, 544 U.S. 336 (2005)."

Evans's alarm is overstated because the reliance element was eased by the Supreme Court in Basic v. Levinson, 485 U.S. 224 (1988). the Court said

“Requiring a plaintiff to show a speculative state of facts, i.e., how he would have acted if material information had been disclosed, or if the misrepresentation had not been made, would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market.”

Thanks to Kevin LaCroix, D & O Diary for the update. Kevin's latest is always available on my blogroll on the right.

S. 1551 - Arlen Specter measure would restore aiding and abetting liability in securities fraud cases

There is no stronger case for judicial recognition of an implied cause of action than when a statute declares a wrong. Aiding and abetting a fraud has been a crime for 100 years. 18 U.S.C. § 2 declares:

“(a) Whoever commits an offense against the United States or aids, abets, counsels, commands, induces or procures its commission, is punishable as a principal”

That substantial aid to a fraudulent scheme is actionable has been declared, as Justice Stevens observed (dissenting) in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, 511 U.S. 164 (1994):

“In hundreds of judicial and administrative proceedings in every Circuit in the federal system, the courts and the SEC have concluded that aiders and abettors are subject to liability under §10(b) and Rule 10b-5.”

Yet the U.S. Supreme Court, in Stone Ridge Investment Partners v. Scientific Atlanta, 552 U.S. 148 (2008), held that liability even for active aiding and abetting of a fraud is not permitted under the Securities and Exchange Commission Act of 1934, 15 U.S.C. §§ 78a et seq., and the SEC’s Rule 17 C.F.R § 240.10b-5 which supports a tort remedy for securities fraud.

A measure introduced by Arlen Specter (D. PA) the Evaluating S.1551: The Liability for Aiding and Abetting Securities Violations Act of 2009 would overturn Stone ridge and embrace a private cause of action against those who knowingly aid and abet a fraud - whether law firms, accountants, or investment advisors.

Recognition of a private cause of action in tort is an elementary proposition. It is embraced by the Restatement of Torts (2d) which declares, in § 876 (b) that an actor is liable for harm resulting to a third person as a result of the tortious conduct of another “if he . . . knows that the other’s conduct constitutes a breach of duty and gives substantial assistance or encouragement to the other.”

At a hearing September 17, 2009 held by the Senate Judiciary subcommittee on crime and drugs Columbia Professor John Coffee supported the measure - albeit urging caps on damages for secondary tortfeasors. In a post-Madoff world, in which the SEC was hoodwinked by a con artist whose scheme was exposed (to no effect) by an independent observer - Harry Markopolos, the need for a private remedy seems blazingly clear. Coffee’s written testimony is HERE. Video of the hearing is HERE. The complete record of the hearing can be found HERE.