Chapter 16 - § 16.11 • AIDING AND ABETTING LIABILITY UNDER RULE 10b-5

• Jurisdiction: Colorado

§ 16.11 • AIDING AND ABETTING LIABILITY UNDER RULE 10b-5

The Supreme Court has made it clear that there is no civil liability for aiding and abetting another who is liable for violations of Rule 10b-5. The first case in a trilogy of cases was Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.²²⁵ in 1994. This was followed in 2008 by Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc.²²⁶ The third case that nailed civil aiding and abetting liability shut was the 2011 case of Janus Capital Group, Inc. v. First Derivative Traders.²²⁷ As discussed below, however, secondary actors may be liable as primary participants under Rule 10b-5.

§ 16.11.1—The Central Bank Of Denver Case

Until 1994, numerous federal district and appeals courts held that persons could be found liable for aiding and abetting violations of § 10(b) and Rule 10b-5. This was a judge-made doctrine not found in the securities laws. The principle held a person (the aider and abettor) who aids and abets another person who violates the securities laws (the primary violator) equally liable with the primary violator.

Earlier, in Herman & MacLean v. Huddleston,²²⁸ the Supreme Court expressly reserved the question of whether aider and abettor liability was available in private damage actions under Rule 10b-5. On April 19, 1994, however, the Supreme Court issued its opinion in the case of Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.²²⁹ In that case, the Supreme Court held (on a 5-4 vote) that a private plaintiff may not maintain an aiding and abetting claim under 1934 Act § 10(b).

In the Central Bank case, Central Bank had acted as a bond trustee for 1986 bonds issued by a land developer in Colorado Springs. The developer issued 1988 bonds based on substantially the same appraisal, notwithstanding the deterioration of the market during that period. Central Bank was aware that the value was optimistic based on work of its own staff as well, but, for various reasons unrelated to the 1988 bond issue, agreed to delay a new appraisal until year-end. After default, purchasers of the 1988 bonds then sued Central Bank for "aiding and abetting" the 1988 bond issuance by having delayed the appraisal. The U.S. District Court for Colorado granted summary judgment to Central Bank, while the Tenth Circuit reversed.²³⁰

In reaching its decision, the Supreme Court noted Ernst & Ernst v. Hochfelder²³¹ (which held that negligence was not sufficient to maintain a § 10(b) action) and Santa Fe Industries, Inc. v. Green²³² (which held that the 1934 Act did not provide a remedy for all breaches of trust, but rather only those with a nexus to the violation of the federal securities acts). The Court also noted Chiarella v. United States,²³³ where it stated "not every instance of financial unfairness constitutes fraudulent activity under § 10(b)."

The Court also reviewed the statutory intent of § 10(b), finding that "Congress knew how to impose aiding and abetting liability when it chose to do so," referring to:

• The Act of March 4, 1909, § 332, 18 U.S.C. § 2 (general criminal aiding and abetting statute).
• The Packers and Stockyards Act of 1921, 7 U.S.C. § 192(g) (civil aiding and abetting provision).
• The Commodity Exchange Act, 7 U.S.C. § 25(a)(1) (civil aiding and abetting liability for private suits under that act).
• The National Bank Act, 12 U.S.C. § 93(b)(8) and the Federal Reserve Act, 12 U.S.C. § 504(h) (both of which define violations to include aiding and abetting).²³⁴

The Supreme Court found that Congress had taken a "statute-by-statute approach to civil aiding and abetting liability," and had even provided SEC enforcement powers against aiders and abettors (1934 Act §§ 15(b)(4)(E) and 21, against brokers and dealers who aid and abet violations); and Insider Trading Sanctions Act (added a civil penalty for persons aiding and abetting insider trading violations).²³⁵

Notwithstanding SEC (and other amici) arguments to the contrary, the Court concluded that there was no congressional intent for an aiding and abetting claim under § 10(b). The Court noted that "it does not follow that the objectives of the [securities laws] are better served [by far-reaching aiding and abetting liability]. Secondary liability for aiders and abettors exacts costs that may disserve the goals of fair dealing and efficiency in the securities markets."²³⁶

In denying the availability of an aiding and abetting remedy, the Supreme Court noted that "[a]ny person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met."²³⁷

Justice Stevens wrote a dissent in which he complained that the Court "gives short shrift to a long history of aider and abettor liability under § 10(b) and Rule 10b-5."²³⁸ He further noted that the long history of aider and abettor liability without congressional interference indicates "tacit approval" of the provision similar to the tacit congressional approval of a private right of action under Rule 10b-5, itself.²³⁹ Justices Blackmun, Souter, and Ginsburg joined in the dissent.

Section 20(e) of the 1934 Act, added by the National Securities Market Improvement Act of 1996, reinstates aiding and abetting for persons who "knowingly or recklessly provides substantial assistance to another person in violation of [Rule 10b-5]." The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act)²⁴⁰ broadened § 20(e) of the 1934 Act to provide that persons who recklessly provide substantial assistance can be held liable under the 1934 Act.²⁴¹ Gross negligence is not sufficient for aiding and abetting liability under § 20(e).

Additionally, the Dodd-Frank Act requires that the Comptroller General study the effect that authorizing private rights of action against persons aiding and abetting securities law violations may have on the market for securities. The Comptroller General must submit its report within one year.²⁴²

§ 16.11.2—Liability As Primary Participants

Secondary defendants may be liable as primary participants under Rule 10b-5, even after Central Bank, when their direct actions (not assistance) led to the damages. Generally this liability follows one of three tests:

The Bright Line Test

A majority of courts that have considered the issue have applied the "bright line test" — holding that, to be liable, the secondary actor must directly or indirectly make a false statement or omission. In Lattanzio v. Deloitte & Louche LLP,²⁴³ the court found that an auditor could not be liable for having reviewed quarterly financial statements that later proved to be materially false.²⁴⁴ The court noted that the results of the accountant's review "were never communicated to the public," and the mere fact that the review requirement exists was not sufficient to impose primary liability on the accountants. With respect to the audited financial statements, the court noted that that the accountants had issued going concern warnings and other indications of a risk of possible bankruptcy and affirmed the trial court's dismissal. In Overton v. Todman & Co.,²⁴⁵ the same court held that an auditor may be primarily liable for violations of § 10(b) and Rule 10b-5 when it:

(1) makes a statement in its certified opinion that is false or misleading when made; (2) subsequently learns or was reckless in not learning that the earlier statement was false or misleading; (3) knows or should know that potential investors are relying on the opinion and financial statements; yet (4) fails to take reasonable steps to correct or withdraw its opinion.²⁴⁶

The difference between Lattanzio and Overton is that in Overton, the auditors made a false or misleading statement; in Lattanzio, although there were errors, the auditors did not make a false or misleading statement as to the unaudited financial statements, and the errors in the audited statements were not material because of other warnings.

In SEC v. US Environmental, Inc.,²⁴⁷...