When Will It Finally End: The Effectiveness of the Rule 10b-5 Private Action as a Fraud-Deterrence Mechanism Post-Janus

• Author: Justin Marocco
• Pages: 633-667

When Will It Finally End: The Effectiveness of the

Rule 10b-5 Private Action as a Fraud-Deterrence

Mechanism Post-Janus

I wasted no time; I got some people in, we drafted a rule, we

presented it to the Commission, and, without any hesitation, the

Commission tossed the paper on the table saying they were in

favor of it. One Commission member said, “Well, we’re against

fraud, aren’t we?” So, before the sun was down, we had the rule

that is now Rule 10b-5.1

The above is Milton Freeman’s succinct description of the

process behind the passage of Rule 10b-5. Known as the “father of

Rule 10b-5,” Freeman guided the effort that culminated in the

rule’s birth.2 Passed pursuant to Section 10(b) of the Securities

Exchange Act, Rule 10b-5 is a broad antifraud provision that

essentially prohibits all fraud in connection with the purchase or

sale of securities.3 At its birth, not even the “father of Rule 10b-5”

could predict what his child would one day become.4 No one

anticipated that Rule 10b-5 would give rise to a private right of

action that would eventually become the subject of thousands of

opinions attempting to define it.5 Neither Section 10(b) nor Rule

10b-5 contains language providing for a private cause of action

under the rule.6 Instead, federal courts have implied it.7 Hence,

when courts look at the 10b-5 private action, they are dealing with

Copyright 2013, by JUSTIN MAROCCO.

1. Milton V. Freeman, Colloquium Foreword, 61 FORDHAM L.REV. S1,

S1–S2 (1993) (emphasis added). This occurred prior to the passage of the

Administrative Procedure Act of 1946, so the procedure to pass a new rule was

much more informal than in the present day. Seeid. at S2.

2. See id. at S1, S3.

3. Rule 10b-5 prohibits: (1) employing “any device, scheme, or artifice to

defraud”; (2) making “any untrue statement of a material fact or [failing] to state

a material fact necessary in order to make the statements made, in the light of

the circumstances under which they were made, not misleading”; and (3)

engaging “in any act, practice, or course of business which operates or would

operate as a fraud or deceit upon any person, in connection with the purchase or

sale of any security.” 17 C.F.R. § 240.10b-5 (2011).

4. See Freeman, supra note 1, at S2.

5. See W. Taylor Marshall, Note, Securities Law––The Securities

Exchange Act of 1934––‘Round and ‘Round We Go: The Supreme Court Again

Limits the Circumstances in Which Federal Courts May Hold Secondary Actors

Liable Under Section 10(b) and SEC Rule 10b-5, Stoneridge Investment

Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761 (2008), 31 U.ARK.

LITTLE ROCK L.REV. 197, 204 (2008); see also Freeman, supra note 1, at S2

(evincing that the future of Rule 10b-5 was unexpected at its inception).

6. See discussion infra Part I.A.

7. See discussion infra Part I.A.

634 LOUISIANA LAW REVIEW [Vol. 73

“a judicial oak which has grown from little more than a legislative

acorn.”8 The Securities Exchange Commission (SEC) passed Rule

10b-5 to prevent fraud in connection with the purchase and sale of

securities, and, despite a lack of express language providing for it,

the private right of action is the method used to implement this

deterrence purpose.9

The Supreme Court’s recent holding in Janus Capital Group,

Inc. v. First Derivative Traders puts the usefulness of the 10b-5

private action as a fraud-deterrence mechanism in serious doubt.10

In Janus, the Supreme Court clarified who “makes” a statement

under Rule 10b-5.11 The Court determined that “the maker of a

statement is the person or entity with ultimate authority over the

statement, including its content and whether and how to

communicate it.”12 Additionally, in a footnote, the majority

provided that attribution of a statement is key evidence regarding

who “makes” the statement.13 Consequently, Janus’s holding

opens the door for lower federal courts to absolve corporate

officers of liability for statements attributed solely to the

corporation, even if those statements were prepared and distributed

by the officer on the corporation’s behalf.14 This Note argues that

Janus has severely limited the 10b-5 private action’s effectiveness

as a fraud-deterrence mechanism and, in so doing, has removed

much of the disincentive for corporate officers to commit fraud.

Therefore, the SEC or Congress must step forward and take action

to reestablish the 10b-5 private action as a fraud-deterrence

mechanism.

Part I of this Note provides a brief background regarding

Section 10(b) and Rule 10b-5, as well as a discussion on how

8. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 737 (1975).

Justice Rehnquist’s oft-repeated analogy refers to the inability to decipher

Congress’s intent regarding the “contours of a private cause of action under rule

10b-5” based solely on the language of Section 10(b). Id.

9. See Freeman, supra note 1, at S1–S2; S. Michael Sirkin, The Deterrence

Paradox: How Making Securities Fraud Class Actions More Difficult for

Plaintiffs Will More Strongly Deter Corporate Fraud, 82 TEMP.L.REV. 307,

311 (2009) (quoting Secs. & Exch. Comm’n v. Capital Gains Res. Bureau, Inc.,

375 U.S. 180, 186 (1963)). Freeman recognizes that the primary impetus behind

the passage of Rule 10b-5 was to prevent a company president from benefitting

from his dishonest co nduct. See Freeman, supra note 1, at S1.

10. 131 S. Ct. 2296 (2011).

11. See id. at 2301.

12. Id. at 2302.

13. See id. at 2302 n.6.

14. Federal courts have exclusive jurisdiction over the private 10b-5 right of

action. See 15 U.S.C. § 78aa (Supp. V 2011); see also Will v. Calvert Fire Ins.

Co., 437 U.S. 655, 659 (1978).

2013] COMMENT 635

federal courts have implied the 10b-5 private cause of action. The

discussion then shifts to the Supreme Court’s decision in Central

Bank of Denver v. First Interstate Bank of Denver and its rejection

of aiding-and-abetting liability for the 10b-5 private action. Part I

ends with an examination of the Court’s holding in Stoneridge

Investment Partners, LLC v. Scientific-Atlanta, Inc., in which the

Court rejected “scheme liability.” Part II provides an in-depth

discussion of Janus, including the case’s intricate facts, the

majority’s holding, and the dissent’s counterargument. Part II

concludes with a discussion of the primary problem that Janus

created: the potential for corporate officers to escape liability for

their unattributed misstatements. Part III analyzes how the private

action should primarily be used for fraud deterrence and how

Janus eliminates much of this usefulness. Part III also argues that

Janus potentially affects the SEC’s ability to impose aiding-and-

abetting liability through an enforcement action. Furthermore, even

if Janus does not affect the SEC enforcement action, relying on the

enforcement action as the primary means to prosecute fraud and

deter conduct is a recipe for disaster. Finally, Part III recognizes

that Janus could signal a revival for Section 20(b) as an instrument

to impose liability on corporate officers who use their company as

the vehicle to carry out their fraudulent schemes. In Part IV, this

Note concludes by proposing a solution in the form of either a

federal statute or SEC rule addressing the problems that Janus

created, specifically the potential for corporate officers to escape

liability for their fraudulent misstatements.

I.LEGAL BACKGROUND

A. Statutory and Regulatory Background

Congress enacted the Securities Exchange Act of 1934 to deal

with the weaknesses in the national securities markets that were

thought to have contributed to the market crash of 1929 and the

ensuing Great Depression.15 The Act regulates the post-distribution

trading of securities16 and seeks to institute a full-disclosure

15. See Robert J. Grubb, II, Attorneys, Accountants, and Bankers, Oh My!

Primary Liability for Secondary Actors in the Wake of Stoneridge, 62 VAND.L.

REV. 275, 281 (2009); Diana L. Hegarty, Rule 10b-5 and the Evolution of

Common-Law Fraud—The Need for an Effective Statutory Proscription of

Insider Tradition by Outsiders, 22 SUFFOLK U.L.REV. 813, 819 (1988).

16. Cent. Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164,

171 (1994) (citing Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 752

(1975)). The Securities Act of 1933 regulates the initial distribution of securities

to investors, whereas the Securities Exchange Act of 1934 regulates securities